Transforming personal finance since 2011

#57 — 100 minus your age... / Part III

January 30th, 2020

By Andrew Craig

Reading time: ~ 12 minutes

In my last article I covered some key ideas about investment in general – particularly the importance of ignoring the news, the crucial difference between investing and trading and the merits of only changing your most fundamental financial arrangements every five years or so.

Today in this third article in the series (part 1 / part 2), I will have a look at how you might think about the “aggressive” portion of your investments, as promised.

I had intended for this article to go out on Tuesday of this week but my wife, Rachel, and I were lucky enough to welcome our second child into the world last Friday morning which put a bit of a dent in my ability to write as you might expect! Oscar William Craig arrived at 3.29am and is a very large and vocal young chap. Mother and baby are doing very well and his sister (Ella) is a big fan (which is a relief!).

…anyway - I digress. I would also note here that this will be the first of at least two articles covering my thoughts on “aggressive” investments – rather than just this one as originally intended. The rest of the Plain English Finance Team are always telling me that my articles are far too long and risk boring the pants off our audience. I had originally intended for this to be a three part series as you know but as I have gone along with the process of getting my thoughts written down, covering all the ground I want to cover has run to several thousand words. Rather than write an article the length of a university dissertation, I thought it might be better to write a handful of slightly shorter ones instead.

So - today – I’m going to give you some thoughts on a couple of big equity indices – namely the S&P 500 and MSCI World. I will then cover a number of other options you might consider as “aggressive” potential investments in a future article or three (depending on word-count). Specifically, these articles will discuss things such as Smaller Companies, Biotech, Robotics, AI and similar things that occur to me as I go along…

As I said last time - there are a vast number of things you could invest in which can be described as “aggressive” – i.e. higher risk and higher reward as a result (theoretically at least). Two other points I made were the importance of keeping things simple and my contention that long-run investment success is probably something like 90% admin and 10% fund selection. So let’s start by looking at a really simple approach you might take:

Keep it simple Mark II

Arguably the very simplest thing you might do with the “aggressive” proportion of your “100 minus your age” allocation to investment would be to own a large equity market of some kind.

You will hopefully recall that the original idea of “100 minus your age” was to put “x%" in “defensive” bonds and the rest in “aggressive” equities (shares) based on your age.

Part of the reason for this rather simplistic approach had to do with the financial products that existed when this idea first came about. Go back a few decades and financial services weren’t very sophisticated – certainly as compared to today. There weren’t that many financial products available for the ordinary investor. If you were a “normal” investor based in the US, your financial adviser was just about able to get you positioned in the Dow Jones and US Treasuries or, for people on this side of the Atlantic, the FTSE 30 (as it was before 1984) and UK Gilts.

The situation today is night and day different. Today it is possible to invest in pretty much anything that you might think of using something called an ETF – Exchange Traded Fund (if you want a reminder of what these are, please check out page 185 of my book.

To give you an idea of the insane choice out there nowadays, in an article (paywall) from August of last year, James Mackintosh of the Wall Street Journal wrote that:

“There are indexes (ETFs) for everything; no one knows exactly how many, but it is certainly in the millions….”

On the one hand – this is actually quite amazing. It has literally never been easier in the whole of human history for you to implement any investment idea you might have. Set against this, however, is something called “the paradox of choice.” This is the basic idea that the more choice you have, the more likely you are to suffer indecision and not actually get the results you want in life – whether you’re talking about choosing a song on Spotify, a movie on Netflix or, arguably rather more importantly, what to do about your investments!

The S&P 500?

One way to combat this reality is to try and keep things really simple. Arguably the easiest thing to do with that in mind would be to allocate the “aggressive” proportion of your hard-earned savings to a big, liquid stock market ETF. The biggest and most liquid of these is America's S&P 500.

Regular readers will be aware by now that the S&P has delivered exceptional returns since the last financial crisis, rising around 400% between March 2009 and today. This is clearly pretty remarkable, but it is also almost certainly quite a misleading time frame to consider (something too many commentators are doing at the moment). First, because it is highly unlikely that you would have started investing in March 2009 at the low. Secondly, because the last ten years or so have been highly unusual for a raft of structural reasons that I have written about in the past.

Going back to 1957 – when it was first created in its current form – the S&P 500 has returned about 8% a year. I would argue that this gives us a better sense of the long run returns you might expect from owning the S&P.

The performance of the main US stock market indices in the last decade, however, is not far off unprecedented. I would argue that this has been driven by a number of factors that are unlikely to be around forever. I am not a fan of letting the news drive your investment decisions as I explained in some detail in the second article of this series. That having been said - it is perhaps worth at least given consideration to certain longer-term themes. In the last ten years, the S&P 500 and the other main US indices have been driven in the main by the success of a handful of tech companies that have been the beneficiaries of one massive structural theme - namely “tech 2.0”. This is most obvious when you consider the fact that five of the top six biggest companies in the US (and the world and in history (!)) are Apple, Microsoft, Amazon, Alphabet (Google) and Facebook but it is also the reason why companies like JP Morgan, VISA, Mastercard, Bank of America, AT & T and Intel are all also in the top 20 and are each worth well over $250 billion.

The top 50 companies in the S&P 500 (i.e. only the top 10% of those 500 companies by number) account for more than 50% of the value of the index. The last ten years has been characterised by a long and strong period of American exceptionalism and concentration in equity market success. This has been a function of how much our lives and our companies have been changed by the internet, cloud computing and the ubiquitous use of smart phones.

For what it is worth, I think this theme quite likely has more to go, but I would also argue that the rest of the world is catching up – particularly when you look at companies like Alibaba and Tencent – two Chinese tech companies which are now comfortably in the top 20 biggest companies in the world.

China Next?

I would argue that this last example is extremely relevant to what the next ten (or more) years might look like. Research and development (R&D) is a lead indicator for where future value is likely to be found. The US has led the world in this respect for not far off a century – arguably the key reason they have also led the world in creating massively valuable companies. It is quite clear that this is changing, most particularly when you consider what is going on in China.

As Alec Ross wrote in his excellent book “The Industries of the Future”:

“While the portion of global research and development (R&D) in the United States fell from 37 percent to 30 percent in the last decade, China’s share… increased from about 2 percent to 14.5 percent.”

Chinese patent applications zoomed past the US in 2014 and are now miles ahead of the rest of the world. There are questions about the quality of many of those patents, but it seems clear that this is still a key theme. Long-time readers of my articles may know that I think the biotech industry is going to be one of the biggest drivers of equity value in the next few decades. The companies that find effective cures for things like cancer, dementia and diabetes will quite likely be the Apples and Googles of the future in terms of size and value.

The Chinese government has made this a massive strategic focus for some time now.  This is something I can attest to personally as I spent ten days in China last month visiting Chinese biotech companies, industrial parks and medical facilities, including one of the biggest hospitals in Beijing - an absolutely extraordinary place.

Much of the work that is done by biotech companies in a bid to find such cures is done with something called a gene sequencer. To quote Alec Ross again:

“The Beijing Genomics institute (BGI) is now the largest genomics center (sic) in the world, with more sequencing machines than the entire United States.”

Let that statement sink in for a moment. This is big news and one of many such data-points that I would argue mean the next decade or two could very well look quite different to the last couple – in terms of equity value-creation at least. The US stock market has led the charge for the last ten years, but, as any smart ten-year-old will tell you, what goes up must eventually come down. Given how dominant the US has been for the last decade and given the direction of travel in places like China (and India too for that matter), might it be better to hedge our bets a bit?

The MSCI World

One way of doing this, would be to use a broader and more global equity index. Returning to our “keeping things simple” theme – we might then look for the biggest and most liquid global equity index in the world. In doing so, we need look no further than something called the “MSCI World”.

The MSCI "Morgan Stanley Capital International" World Index owns just over 1,600 of the biggest companies in the world – from all over the world. In the last ten years it has returned just over 10% a year on average.

So – one idea for the “aggressive” bit of your money would be to just buy the S&P 500 or MSCI World index and have done with it. My own view is that the MSCI World could well be a better option going forwards for the reasons I’ve given above. I think there is a good chance that the success stories of the next ten or twenty years might come from places other than the US and I think there is some decent evidence for this position, but this doesn’t mean I’m right of course! You will have to form your own view.

Don’t forget what “aggressive” means

All of the above having been said – as a reminder of why these funds should only sit in the “aggressive” proportion of your portfolio: In 2008, the MSCI World Index was down 40.33% and the S&P 500 was minus 38.49%. It is very important to remember that whilst these sorts of investments could give you roughly 10% returns over time and +30% years now and then as happened in 2019, they can also have big down years.

This needn’t be a problem for your ability to grow wealth over the long term IF you are properly and appropriately diversified (by using something like “100 minus your age” of course) and if you have a plan, stick to your guns and ignore the news – but you MUST have just such a plan and you must stick to it.

I would remind you again of the excellent John Stepek quote I used in my last article:

“There are many roads to ruin in the markets – some of them longer than others – but one sure-fire way is to set out as a buy-and-hold investor and then attempt to turn into a market timer during a bout of market panic. This will do more damage to your portfolio than following one approach or the other...”

What else? Smaller Companies, Biotech, Robotics, AI and other animals...

Choosing the MSCI World or S&P 500 is one approach and does a good job of keeping things nice and simple but a part of me does wonder if returning roughly 8-10% a year is worth all that extra risk given the fact that you might suffer 40% down years.

If you’re really going to “go for it” with your high-risk “aggressive” investments – might there be ways of aspiring to make a bit more than 10%? The simple answer here is “yes” – but with reservations of course.

Given this has run to north of 2,000 words in the usual fashion, I will give you my thoughts on this sort of thing in the next one…