How to Fund the Life You Want by Robin Powell and Jonathan Hollow

Author:Robin Powell and Jonathan Hollow
Language: eng
Format: epub
ISBN: 9781399404594
Publisher: Bloomsbury Publishing Plc

We need to take a brief detour into pessimism here, which helps explain some of the thinking behind this portfolio. Although not all agree, many eminent academics (notably Dimson, Marsh and Staunton) are predicting lower returns in the future than investors have enjoyed in the past.14 They reason that the returns on bonds haves been low for a long time and show no signs of rising. They argue that the ‘risk premium’ future investors will get by investing in equities has a ceiling. They argue history shows that this is linked to the returns on bonds. In their view, a ‘balanced’ portfolio of 70 per cent equities and 30 per cent bonds will yield an after-inflation rate of return (‘real return’) of just 2 per cent.

The ambitious portfolio we have set out above therefore contains only 20 per cent bonds. If we calculate its pre-inflation (nominal) rate of return based on the longest historical averages we can find, the nominal rate is high – 12 per cent. But let’s dampen that down, assuming that Dimson, Marsh and Staunton are right. Even after that, it’s still plausible that this portfolio could give a 9–10 per cent pre-inflation rate of return and therefore a respectable after-inflation rate of return. So who is this portfolio good for? In our view, you would select this type of portfolio for one of two reasons:

• You have a ‘medium-towards-high’ risk appetite. If the stock market falls by 20 or even 30 per cent in one year, you’ll not be too upset. You will know that next year it will probably rise and in six or seven years’ time, it will almost certainly have recovered.

• Your financial situation is such that you can’t live with a lower rate of long-term growth.

This second point is fine if it combines well with the first. However, if you are risk-averse and all the same need higher growth, that’s the most uncomfortable combination possible. To compound it, that’s probably the scenario with the strongest case for handing over your money management to an adviser. This is because they won’t have the same strong emotions as you about the money they are managing and are more likely to make rational and consistent decisions. But unfortunately, as their additional adviser’s fee will always claim a substantial fraction of your growth, it will then further ratchet up your need for growth.

Cash for a crash

There is an approach to investing that can help you to deal with the psychology of loss and we recommend it. However, we recognize its ideal form may not be feasible for everyone. This is the use of cash as ‘self-insurance’ against a stock market crash.

If the stock market falls – let’s say, a dramatic fall of 40 per cent – the historical evidence shows it is likely to recover eventually. How long will that take? Unfortunately, nobody knows, despite innumerable articles and books trying to dissect what happened in different markets and average out the different cycles. Some recoveries took four to six years, others took as long as 13.

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