Longstanding readers will know that I have been an avid user of leverage, ever since I used it to buy my Dream Home in January 2016. At that point I was able to borrow funds, very flexibly, secured on my portfolio. And rates were well under 2% in all major currencies.
When I started my leverage journey, I was borrowing over GBP1m, in a ratio of 3:2 GBP:USD. The rates on both were, from memory, between 1% and 1.5%. At this point the interest is more than covered by the after-tax dividend income on the securities, leaving any capital gains or untaxed income as leveraged upside. My main concern from having debt was not the financing cost, but the leveraged exposure it left me with – a 10% drop in markets would have hit my portfolio’s value by around 15%, and potentially left me vulnerable to the bank calling in some of the debt (via ‘margin calls’).
Since January 2016, base rates have started to climb – for the first time since the Global Financial Crisis in 2008. This change was long heralded and a long time coming.
I’ve been aware of the change in rates posture, but not been paying too much attention. After all UK base rates have risen to only 0.75%. Euro rates haven’t changed. But I must admit I had somewhat missed the fact that US base rates have risen above 2%. Two per cent! That’s becoming a proper base rate.
In the meantime, I’ve succeeded in reducing my leverage very significantly. In debt terms, by around half. In loan-to-value terms, by more than that – because my portfolio has grown as my debt has shrunk.
I recently reviewed the rates I’m paying for my margin loan and finally clocked that now my USD debt is costing me over 3.25%. IB’s rates start at 3.7% and then drop to 3.2% up to $1m of loan. This much higher interest rate has made me reconsider my target leverage.
With USD rates over 3%, but my loan to value being around 15%, my main concern now is the financing cost / spread, not the level of exposure/risk. Paying interest of over 3.25% out of after-tax income now requires yields of 6% or more, which is getting into ‘high yield’ securities only – something that I know from experience tend to deliver pretty poor total returns. Of course capital gains may yet deliver an overall gain, even after tax and interest costs, but that is much more of a gamble than I faced two years ago, especially with October’s correction still a very recent memory.
Diversification is the “only free lunch in investing”, and I love it. However, I came to the conclusion as I started tracking my investment performance rigorously that I had overdone it. Since that realisation I have been rowing back slightly. I appraised my progress recently, and this rather dry blog post sets out my findings.
I track all my investment portfolio holdings in one single investment spreadsheet. One advantage of this approach is that I have a consolidated view of my portfolio which ‘de-dupes’, and makes it fairly easy to see large positions that amass when I buy the same ETF in multiple portfolios.
What is the appropriate number of holdings to diversity accurately? You’ll find as many answers as responders to that question. But consensus seems to suggest 20 holdings is more than sufficient, especially if you are using collective securities such as index funds or ETFs.
When I began my unified tracking I had no fewer than, erm, 228 holdings. Over two hundred holdings.
Almost every single one of my holdings I have personally chosen. With a reasonable amount of consideration, time and of course fees associated. Multiply this by 228 and pretty soon it sounds like a lot of time wasted.
How did I end up with 228 holdings?
Here is the breakdown from late 2013:
- 29 ETFs. Of these 29 (15%) of them were ETFs, amounting to just over 30% of the total portfolio value. VUKE was originally my largest, at just under 10% of my total portfolio; these days IUSA is my biggest, with about 5% of my portfolio.
- 57 Funds. Ouch. This was a testament to having used my fair share of IFAs and private bankers over the years. This lot added up to around 25% of my portfolio’s value. The largest holding was about 2% of the total.
- 122 equities. Half my holdings are directly held equities. They amount to about a third of my total portfolio value. They included, originally, 57 holdings of less than £10k each.
- 12 bonds. Individually held bonds are quite exotic things really so no wonder I don’t have many. Though my largest is 2% of my portfolio, the total amounts to only 5%.
- 8 cash equivalents. Eight! Five separate currencies, held in 8 different ways in total.
I decided, roughly when I wrote my Investment Philosophy, that this portfolio was needlessly complex and should be slowly pruned. The complexity cost of such a large portfolio is significant:
- Higher transaction fees. My minimum opening position used to be around £1000. At this level I am doing a lot of transactions and my in/out fee is over 2% even before stamp duty. With a higher average trading amount I cut my fees.
- Higher paperwork/admin time. Almost every single one of my holdings spits out income payments. I track many of these individually. Typing in £0.31 of tax credit on a Fidelity account for some <£2000 holding is not good use of time.
- Reduced mindshare. Warren Buffett has long espoused the ‘20 punch card‘ approach. He has a point. His point is choose wisely, and get it right – and limiting yourself to fewer bigger decisions improves your odds. And of course to stay up to date with 20 investments is far easier than keeping tabs on 228 investments.
- Carrying deadweights. Looking back at my 5 year old portfolio I recognise holdings that I knew were suspect, but I ducked the challenge of making a decision to liquidate them. When they’re small, the damage they are doing to the portfolio doesn’t feel worth the bother.
- Diluting my best picks. Some of my best performing investments have been my smallest. I have had a hunch, and invested £2k, £5k, or something similar. If I’d made my entry ticket bigger, and adopted a different approach to selling out duds, I think I’d have made more money without taking on appreciably more risk.
In any case, after quite a lot of gradual pruning, optimising and spring cleaning, my current portfolio looks considerably better on my ‘overdiversity’ measures:
A new UK tax year has just begun, and with it a new annual ISA allowance of £20k each. ISAs are an amazing tax-break for investors who are UK taxpayers. I love them, and have a goal to get my ISA portfolio to £1m+. I’ve been posting updates annually about this (e.g. here, and the one before).
Why is being an ISA millionaire cool? The £1m mark is just an arbitrary number, after all – unlike UK pensions which are capped for most of us at £1m. A million quid maintains an allure, even after the ravages of inflation. And sensibly invested it should produce an annual income of £35k-£40k, tax free – whereas a £1m pension’s income is taxable, if it is taken.
Since the government lifted the allowance to £20k per person a few years ago (an un-noticed marriage tax break for wealthy, i.e. mainly Tory, voters), even
ignorant ultra-conservative investors using just Cash ISAs can become ISA millionaire-couples in ‘only’ 25 years. But their £million won’t be worth as much as it would have been when they started, and they won’t benefit from tax-free compounding over the 25 years.
£20k here, £20k there and, pretty soon, you’re talking real money
ISAs in their current form started in 1999, when they replaced other tax-friendly savings arrangements such as PEPS, TESSAs.
Any single person who’d topped up their ISA to the maximum every year since 1999 would have, if they have just topped up their 2018/19 ISA, invested £206k in their ISA. If this money was invested in a low-cost FTSE All Share index tracker, with no withdrawals, it would today be worth around £380k. A married couple who have doubled up the whole way will be sitting on a combined ISA pot of double this, which is over $1m. So, in dollars, a pair of wealthy ISA-loving investors would be ISA millionaires if they have achieved market average returns over the last 19 years.
Being an individual ISA millionaire in pounds is much harder. But if you were saving hard using the PEPs/TESSAs that preceded ISAs, you had a crucial starting advantage. This is one of the ways that the most famous UK ISA millionaire, Lord (John) Lee did it. But if, once ISAs came along, you achieved only average market returns, you’d have had to begun your ISA journey with £187k of savings.
How could people have begun their ISA journey in 1999 with £187k savings? The Capital PEP, which would have been the best vehicle to have used, started in 1987 with an annual allowance of £2.4k. By 1990 it had risen to £6k. But this means the most you could have invested before 1999 was £64.2k.
What were the chances of turning £64k into £187k in 12 years? As it turns out, the chances were very good. The 1991-95 boom saw the FTSE All Share return over 20% per year in four of the five years. So an ‘all in’ PEP investor, achieving average returns, would have had £159k in their ISA account on day 1. Maintaining average returns and continuing to be ‘all in’ would have got them to around £850k today.
In fact, an ‘all in’ investor like John Lee would have only needed to outperform the market by 1% per year in order to cross the £1m threshold, which they would have done in the last 12 months. Outperforming the market by 1% per year is no mean feat, but there are certainly countless UK investors who have done it. Of course, in the recent Brexit-y era, the more of your investments were outside the UK the more you’ll have beaten the UK market.