Long term investing

T

terminator

Hey guys

I'm in Australia and am 21 and just got a proper job as a public servant. I'm looking at starting a geared managed fund investment for the next 20 years. Can i get some opinons off the experienced stock investors here? Financial planners are dodgy mostly.


Strategy
Contributions: $15,000 a year. i will increase my contributions at 3%, the central bank's underlying inflation target.

Gearing: 50% of my contribution for the year. i.e 7500 per year. Every 5 years i will borrow or pay back money to equalize the LVR to 30%. I will meet all margin calls within that period.

40% in Vanguard diversified bond fund.
(low fees, 60-40 in australian bonds)

60% in Vanguard ASX300 Australian index fund.

Fees: 0.75% for the first 50,000 and 0.35% for amts +100k

I'm thinking of selling it when i'm around 41. (20 years from now)

so is it worth it? i mean will i lose my shirt 20 years from now?


oh and i'll try and rebalance every month with my contributions (i.e paying more/less to the fund thats making peanuts).

i'll probably undertake a big rebalancing every 6 months or so.

should i rebalance longer than 6mths or is 6mths fine?
 
Not sure why you would ask this question on this forum which consist mostly of traders that only hold for days or minutes at a time. I'll give you some advice since I started out as a long only passive index investor but you might be better off looking for a forum dedicated to that kind of stuff. I'm not sure what's the board etiquette about linking to other forums so you'll have to find them with google.

First of all Vanguard is a great mutual fund company. You picked a good one to start with. They have great index funds with very low expense ratios. I recommend them to everyone who doesn't have the time or talent to devote to stock picking. Their actively managed funds aren't to hot. BTW do not buy-and-hold on margin! Time would be working against you which defeats the purpose of holding long term. Not sure what you mean by gearing or LVR.

Your allocation is a little more conservative then a 21 year old should typically have. Remember you have to outpace inflation and also you have more time to let compound interest work its magic. You also need more international exposure (especially US). I would go for something like 10% cash (+ a emergency stash), 25% bond fund and 65% stock funds split between international and your home country. I don't know if you have tax deferred accounts in your country but those are where you should put the bond fund. If you are worried about risk then sure, go ahead with the 60%/40% allocation. Whatever helps you sleep at night.

You do not need to rebalance every month. All this would do is cause you to worry unnecessarily about market movements. Long term investing means you're suppose to filter out the daily and even monthly noise and look at things on a yearly time frame. I would say rebalance once a year and every ~5 years shift more of your portfolio into bonds.

Now don't go thinking I'm one of those mom-and-pop long term investors. I am a trader and completely addicted to the markets. I mostly write options and also trade the ES intraday. These things are what I tell beginners when they ask me for advice on stocks. I always see newbies with the expectation they will get rich with stocks and buy their own island but looks like you don't have that problem. You are already ahead of the average person in that respect.
 
Quote from terminator:

Hey guys

Gearing: 50% of my contribution for the year. i.e 7500 per year. Every 5 years i will borrow or pay back money to equalize the LVR to 30%. I will meet all margin calls within that period.
More...

What makes you think that you will be able to borrow money at a lower interest rate than the bond fund pays out? You won't. You need to completely rethink your strategy. You also need to contribute vastly more than $7500 a year, or get much higher returns than you get from bond funds. Otherwise you will be 41 and poor for your age.
 
Quote from kxvid:

What makes you think that you will be able to borrow money at a lower interest rate than the bond fund pays out? You won't. You need to completely rethink your strategy. You also need to contribute vastly more than $7500 a year, or get much higher returns than you get from bond funds. Otherwise you will be 41 and poor for your age.
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its not all in bonds. 35-65 split between bonds and stocks.
using the bond fund as a buffer so i never get a margin call. set and forget.

Assumptions:
Average 25 year compound return on stocks: 8%
Average 25 year compound return on bonds: 6%
Weighted average return: 0.65*8 + 0.35*6 = 7.3%

Borrowing Cost: 8%

i can claim the interest as an expense at my marginal tax rate of 30%.
real cost of debt = 8%*0.7 = 5.6%
 
I would normally be at the beach on this U.S. holiday weekend, however the weather here is terrible and it is raining cats and dogs; consequently i am inclined to sit indoors and respond to your post.

I am both a trader and investor. I have been involved with the stock market as an investor for over 40 years, and as an active trader for many fewer years. I have very strong opinions re how to invest for the long run that run counter to conventional wisdom, and i am very certain that i am correct and most others are wrong.

Start by finding a chart of total stock market returns over many years corrected for inflation and omitting dividends. I am only familiar with such a chart for the U.S. S&P 500. This is the single most important chart for long term investors to consider.

You will discover that since the major industrialized nations have gone off of the gold standard and have adopted fiat currencies practically all of the stock market's return is due to inflation and dividends. For mature economies, very little return is due to earnings growth. Once you omit dividends and inflation, the total stock market return is similar to what you would expect from government bonds, and this tends to be a little less than actual real inflation. In other words, if dividends are not included, both investment in bonds and in stocks are liable to result in a net loss of buying power over time. This is completely counter to the Wall Street line. Add to that the greater risk associated with investment in stocks, which is mainly timing risk, and stocks, in general, are not a good long term investment, unless dividends are earned. And with all common stocks there is a risk that when you need to take your money out, as at retirement, the market may be in a bear cycle. This is of course the reason that those who invest in stocks in their youth are wise to convert their portfolios to bonds during bull cycles as they near retirement age.

Bonds have much less timing risk, but on the other hand with low risk bonds you are virtually assured of losing buying power to inflation. In the U.S., bonds whose yields are indexed to inflation, such as TIPS, do not solve this problem because the U.S. government cheats investors by computing falsely low inflation rates. Bonds of other nations with fiat currencies, particularly those nations that run chronic deficits, are subject to the same problem.

Consequently, if you want to make long term investments that will keep up with inflation and have some reasonable probability of providing a significant net positive total return above inflation over time you either must invest only in stocks of sound companies paying dividends, and with histories of increasing those dividends, or you must look elsewhere entirely, such real estate, for example. And the latter has it own risks and problems. And of course with any investment you must consider tax consequences.

I concluded long ago, that for the passive long-term investor, bonds are out of the question in the early years of building an investment portfolio, because they lose to inflation -- at least in the U.S.-- and the only stock investments that make sense are investment into companies paying dividends.

Therefore, if i were your age, and i did not have the time and expertise to trade my portfolio efficiently and profitably, and that can be extremely difficult, and i was set on making investments in stocks, i would buy only stocks of companies that pay dividends and have at least some promise of growing earnings so that dividends can be expected to grow. At your age i would not invest in bonds at all. I would not borrow to invest, i.e., i would not use leverage. I would emphasize investment in companies whose earnings were denominated in currencies of countries that had sound, low inflation economies, i.e., low deficits or balanced budgets, and i would diversify among different sectors and countries. I would not hold many stocks of U.S. companies right now. The long term prospects for U.S. companies for returns above inflation are particularly dim at present. Much of the recent earnings of U.S. companies is the result of foreign operations in currencies other than the dollar so that when those earning are recomputed in dollars they appear to be quite good until they are corrected for real inflation in the U.S. economy. For U.S. investors these much touted earnings are largely illusory.
 
Thanks piezone

i have been quite worried about inflation to as it seems to take a huge chunk outta any future earnings.

So your suggesting sound companies with potential earnings growth.

would more heavy weighting towards emerging markets do the trick?
 
1. Don't borrow - the possible increase in returns is massively outweighed by the risks. Over the long-term, tail risk becomes very high, and that will wipe out any margined account. Your chance of losing your life savings is probably at least 50% over the course of your life if you use any substantial margin.

2. Save up 2 years necessary living expenses in cash, and pay off all your debt, before you invest a penny into the markets.

3. If you own a home, pay off the entire mortgage before you invest a penny into stocks or other long-term risky assets.

4. Once you are debt-free, use low-cost index funds split roughly like this:

15% government bonds (fixed-income)
15% index-linked government bonds (inflation protectioN0
15% REITs
10% Commodities ETF
10% Emerging market stocks
10% G7 blue chip stocks (S&P 500, Dax, Nikkei etc)
10% Domestic small caps
15% Domestic blue chips

If you are more risk averse, increase the bond and TIPS components. If you are more risk-tolerant, increase the equities component.

Rebalance annually (so you benefit more from momentum) and whenever news of short-term panic or buying hysteria (e.g. early 2000 dot coms, housing a couple of years ago) hits the headlines. Rebalancing after a large move is also not a bad idea. Alternatively, for maximum automation just rebalance each quarter if you have any decent gains or losses.

You use the foreign assets to hedge against periods of weakness in the domestic currency, and diversify during times of underperformance of domestic assets. Commodities are good to hedge against inflationary periods such as the 1970s where bonds and stocks get killed. Government bonds needed to hedge against deflation and market panics (e.g. 2008, 1930s, 2000-2002), and provide security of principal along with income to reinvest. REITs add diversification and decent yield. The more uncorrelated, negatively correlated, or weakly correlated assets you have, the better since it raises the efficient frontier and increases the gains from rebalancing.
 
Quote from terminator:

Thanks piezone

i have been quite worried about inflation to as it seems to take a huge chunk outta any future earnings.

So your suggesting sound companies with potential earnings growth.

would more heavy weighting towards emerging markets do the trick?
More...

When investing in countries other than your own you must always be aware of the exchange risk. That is to say, the purchasing power of another currency relative to your own and how that might change over time.

As a long term investor you should be trying to obtain a significant gain net of inflation. If you don't achieve that, then you have let someone else use your money free of charge, or worse yet, if your returns fall short of inflation, you have actually paid someone else to use your money!

Emerging nations go through periods when costs of production, chiefly labor costs, are low compared to productivity. This is good from an investors viewpoint. But consider also the stability of the currency relative to your own currency in whatever emerging nation you wish to invest. For emerging nations this relationship is usually favorable because, in general, productivity that is high relative to production costs leads to a strengthening currency. And this is what you should look for.

So yes, stocks of emerging nations should be considered by the long term investor. But again, let me emphasize that you should select only companies that pay dividends!

Here is a place where i differ strongly from the advice Cutten has given you. He has suggested index funds and TIPS. I strongly advise you to avoid them. The problem with index funds is that they return what the market returns minus a small amount, and i have already explained why this is NOT the return you want. That return keeps you, if you're lucky, a little ahead of inflation due to the components that pay dividends. But why dilute the effect of dividends by including many stocks that don't pay them. That's what will happen if you invest in index funds. (I explained earlier why i don't think TIPS are a good idea.)

Instead, invest in only those components of index funds that pay dividends, and select from only the best of those. When you start out don't spread yourself too thin. Pick out two or three dividend paying stocks you like and build positions in those before branching out further. Avoid choosing so many stocks that you can't easily follow them. And watch very carefully what you have, and make adjustments as necessary.

I never give buy or sell advice as to specific stocks, so I am using only for the purpose of illustration the following as examples of stocks paying dividends that a long term investor might consider. In China there is Jinpan Electric and Petrochina; in Switzerland, Roche; in Norway Norsk Hydro for Aluminum and Statoil for Oil, in the Netherlands there is Philips, in Great Britain and Australia there is Diegeo and Rio Tinto, in Brazil there is Vale, in the US there is Altria, Kraft, Exxon and Conoco Phillips in Belgium there is InBev., etc. This list could go on and on.

Again, for the reason I explained in my original post, and i can't emphasize this too much, the long term investor in the stock market who is investing for retirement purposes and is risk adverse, or should be, needs stocks that pay dividends.
 
Quote from terminator:

its not all in bonds. 35-65 split between bonds and stocks.
using the bond fund as a buffer so i never get a margin call. set and forget.

Assumptions:
Average 25 year compound return on stocks: 8%
Average 25 year compound return on bonds: 6%
Weighted average return: 0.65*8 + 0.35*6 = 7.3%

Borrowing Cost: 8%

i can claim the interest as an expense at my marginal tax rate of 30%.
real cost of debt = 8%*0.7 = 5.6%
More...
I never heard of people using borrowed money for long term investments. Leverage is fine for short term trades, but long term it isn't advisable.

If I were you, I'd trade the money you have now until I'd get up into the 6 figure range. Then start building a non diversified portfolio of excellent companies (buffett style investing).

If you start buying 15k in stocks a year, you will just be averaging into the market. Fills are everything! Averaging in is a losing strategy, one should buy big at good entries, not small at mediocre entries.

Also I'd go 0% bonds at your age.
 
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