Weekend reading: Funny money

What caught my eye this week.

I am late with the links this weekend, so let’s get stuck in with a “show me the money!” moment.

And not just any money, mind, but the 8,800lb coins of Yap Island in the Pacific Ocean:

A Yap island coin: We’re going to need a bigger sofa.

Writing on Medium, Jamie Catherwood explains that:

For centuries, the natives of Yap have used ‘rai stones’ as a form of payment, and store of value.

These ‘stones’, however, were actually gargantuan limestone discs weighing up to 8,800 lbs., and standing 12 feet tall.

The natives ‘minted’ (mined) their currency on Palau Island, and upon their return the Chief of Yap valued each rai stone in front of the entire population.

In the same ceremony, locals would then purchase the currency.

Money is nearly always an abstraction. Trust is usually where the value lies, not in any intrinsic value. Even the gold and silver coins of antiquity were debased and inflated away.

Catherwood writes:

After considering Bitcoin’s value within historical context, it should be clear that criticizing the crypto-currency for being “based on nothing” is a weak argument at best.

He points out that in the past even rather ghoulish religious artifacts have been used as a store of value.

I haven’t made my mind up about Bitcoin yet.

But I’m pretty sure it’d be an easier sell if instead of the dollar, Visa, or PayPal it was up against giant limestone discs and the teeth of long-dead saints…

From Monevator

Taking more risk does not guarantee more reward – Monevator

From the archive-ator: The one number to beat if you want to retire early [Dated in modern thinking, but I still believe a decent goal for ambitious 30-somethings] – Monevator

News

Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!¹

Property buyers dive in as Turkey’s lira plunges – Guardian

New Zealand bans sales of homes to foreigners – BBC

House prices fall at fastest rate since financial crisis, sales tumble 65% – ThisIsMoney

Buy-to-let lending slumps as landlords take fright at tax changes [Search result] – FT

London’s planning application postcode lottery – ThisIsMoney

Emerging markets investors feel effects of Turkey crisis [Search result] – FT

Wake up call: Even Germany looks set to miss its climate goals – Bloomberg

Products and services

Invesco Perpetual at the top of ‘top dogs’ funds list – Investment Week

Banks to check payee’s name matches account number [At last!] – ThisIsMoney

Cracking summer: UK insurers expect rise in subsidence claims – Guardian

Ratesetter will pay you £100 [and me a cash bonus] if you invest £1,000 for a year – Ratesetter

Lovely bubbly: a case for investment in English sparkling wine [Search result] – FT

Why your holiday insurer may refuse your claim – even if thieves break in – ThisIsMoney

Royal Mail changes redirection fees to ‘per household’ rather than ‘per surname’ – Guardian

US angel network wants to mobilize 100,000 women investors – Fast Company

The case for multi-factor funds – Morningstar

Do ESG (environmental, social and governance) funds hurt your returns? – ETF.com

Ticketmaster closes resale sites, but will this fix alleged over-pricing? – Guardian

Millions of Virgin Media customers to be hit with inflation-busting 4.5% price hike – ThisIsMoney

Comment and opinion

We all have it now – Of Dollars and Data

How to change somebody’s mind about investing – Oblivious Investor

Index funds will be just fine confronting cruel markets – Bloomberg

More: Are index fund investors more vulnerable to bubbles? – Behavioural Investment

The half-life of investment strategies – A Wealth of Common Sense

Your lying mind – The Atlantic

Saving rates revisited – My Deliberate Life

How we track our expenses – Young FI Guy

Get rich with simplicity – The Escape Artist

A high net worth investor re-calibrates his portfolio – Fire V London

Is Ted Baker the perfect dividend growth stock? [PDF] – UK Value Investor

Can we afford an electric car? Let’s run the numbers – The FIRE Starter

What could Christiano Ronaldo have to teach us about QE? – The Value Perspective

When earning $1 million a year is not enough to retire early – Financial Samurai

Kindle book bargains

Making a Success of Brexit and Reforming the EU by Roger Bootle – £0.99 on Kindle

Liar’s Poker: From the author of the Big Short by Michael Lewis – £0.99 on Kindle

Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler – £1.99 on Kindle

Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven Levitt & Steven Dubner – £1.99 on Kindle

Brexit

Open letter to the No Deal Brexiteers – Andrew Adonis via Twitter

Disorder, deal, or dead-end: Various Brexit scenarios explored – Reuters

Companies in Brexit ‘supply shock’ as fewer EU nationals arrive – Guardian

Off our beat

The most biggest trend in economics today is too often ignored – Bill Gates via LinkedIn

How to avoid loneliness when you work entirely from home – HBR

More: Four ways to prevent loneliness wrecking your retirement – Reuters

UK asylum seekers’ 20-year wait for Home Office ruling – Guardian

Losing Earth: The decade we almost stopped climate change – New York Times

Australian Geographic nature photographer of the year [Gallery] – Guardian

Vienna is named the world’s most liveable city – ThisIsMoney

And finally…

“Banking may be necessary, but banks, as we know them, no longer are. New financial technologies, and the advance guard of fintech pioneers, are already hammering at their gates.”
– Tim Price, Investing Through The Looking Glass

Like these links? Subscribe to get them every Friday!

1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.

from Monevator http://monevator.com/weekend-reading-funny-money/

Taking more risk does not guarantee more reward

When you’re teaching somebody a new subject, simplifications can creep in. Rules of thumb at best. Outright untruths in the extreme.

For example:

• The simile “as blind as a bat” isn’t true – many bats see better than we do. (Maybe they’re also better than us at similes?)

• Christopher Columbus didn’t think the world was flat. The notion combines scientific and terrestrial exploration into a neat historical parable, but even the Ancient Greeks and Romans knew the Earth was probably a sphere. (Columbus owned books that told him so.)

• Teaching children the classical laws of motion wouldn’t be made any easier by telling them they’ll eventually learn the whole shebang is a gross simplification – that Newtonian physics is a shadow on the wall approximation of the statistical weirdness of quantum mechanics. (Yes, I know I’m oversimplifying here, too!)

• The “i before e except after c” rule often works – but not enough that foreign students can seize the weird exceptionalism of the feisty English language. (Spot the rule’s deficient idiocies there?)

So it is with investing. We say higher returns come with higher risks. That assets that go up and down a lot in price such as shares should to be held with a long-term view, and that braver investors can eventually capture higher returns this way.

But reality isn’t quite so simple. Those higher returns are only expected – not guaranteed – and not all risk is rewarded.

For starters, some risks don’t even come with the expectation of higher rewards:

…the relationship of more risk, more reward does not always hold.

In some circumstances you take greater risk, yet you can’t expect the market gods to reward your chutzpah with greater returns.

Academics call these lousy bets uncompensated risk.

Read our previous article on uncompensated risk to learn if you’re gambling for nothing.

Not every stock market has read the textbooks

It’s also important to realize that even the ‘right kind of’ risk can go unrewarded.

You might expect higher returns, but higher returns are not guaranteed.

For example, we say taking investing in risky equities can be expected to deliver higher returns than super-safe government bonds. But there’s no guarantees, and no timescales.

Indeed there have been long periods where the return from bonds beat shares!

Over the ten years to the end of 2008, for example, the annualized returns from US and UK shares were negative. In contrast, bonds soared.

So much for risk and reward over that decade.

And in case you’re thinking you can handle a ten-year duff stretch – and you will have to over a lifetime of investing – some have had it much worse.

How would you feel if your well-founded risk-taking wasn’t rewarded for half a century?

In 2011 Deutsche Bank reported that:

…for three members of the G7 group of leading industrialised nations, Italy, Germany and Japan, returns from equities have been worse than those of government bonds since 1962.

Indeed, the Italian stock market has even managed to deliver a negative real return over the past half-century, -0.38 per cent on an annualised basis versus +2.64 per cent for bonds, “a remarkable statistic in a world where we are all used to seeing equity outperformance increase the longer you expand the time horizon”, wrote Jim Reid, strategist at Deutsche.

In Japan, government bonds have delivered a real return of 4.17 per cent a year, beating the 2.72 per cent of equities, while in Germany bonds have won by 4.28 per cent versus 3.46 per cent for equities.

Academics – and professional investors – struggle with findings like these. They go against the theory of efficient markets I discussed earlier.

For the market to get it wrong for 50-odd years might suggest:

• Those markets were unusual for some reason.

• We don’t have enough data. (A tossed coin coming up 10 times in a row doesn’t disprove probability theory. Try tossing it a million times.)

• The efficient market theory has limitations.

Personally I’d plump for a mix of all three in the case of Germany, Italy, and Japan.

But I’d also point out that all the leading efficient market academics hailed from the US, a country that has had the strongest, most consistent, and least ‘anomalous’ markets – with the best data, tracking a period including two World War victories, or three if you count the Cold War, and the transition from emerging market to sole global superpower status.

Could this very positive North American experience have biased the research or the conclusions? It seems feasible, but we’ll leave going down that rabbit hole for another day.

The important takeaway here is expected returns are not guaranteed returns. Real-life investors in some countries never saw a sniff of them over a lifetime.

There are several important practical takeaways. For example, somebody on the point of retiring should not have all their money in equities, despite the higher expected returns.

Stock markets usually crash once or twice a decade, and that can chew up your higher returns in the short-term. That’s a big risk, especially for an imminent retiree or a newly-retired one. Statistically you might think it’s unlikely, but if it’s you, and you had no back-up plan, you’re somewhat stuffed.

This is called sequence of returns risk. It’s not a reason to have no shares or own only gold, or any of the other dramatic things people write in the comments on blogs. It’s a reason to own fewer shares, and to diversify.

Risk in real life

I was set thinking about this recently by a family friend.

Having come into some money, she bought me that quintessential millennial brunch of avocado on toast and picked my brains about what to do with it. (The money, not the toast.)

My first step when this happens is usually to send over a bunch of Monevator links, and wait to see if they get read.

If the person doesn’t do their homework (and they usually don’t) then that helps inform where I steer them next.

But in this heartening case my friend read all the suggested articles, and she was keen to let me know so.

For example she explained to me that she now understood that she should never sell, that stock markets always come back, that you have to take risks to win… right?

Er, right, I said. Sort of.

It’s complicated!

Investing is like that. You have to learn a lot to realize there’s a lot you don’t or even can’t know for sure.

One excellent if rather gnomic definition¹ of risk is:

“Risk means that more things can happen than will happen.”

Whereas my friend had taken risk to basically mean “what goes down will come up.”

We can have expectations, given time, but there can be no certainty. If there was certainty, there’d be no extra risk. And if there was no extra risk then there’d be no expected higher returns – because they’d have been bid away by the market, at least in theory.

As blogger Michael Batnick says, you are owed nothing:

This is how stocks work. The stock market doesn’t owe you anything.

It doesn’t care that you’re about to retire. It doesn’t care that you’re funding your child’s education.

It doesn’t care about your wants and needs or your hopes and dreams.

Batnick stressed in that article that he still believes shares are “the best game in town” for long-term investors.

But you must have realistic expectations about your expectations.

Shit happens

To conclude, I’ve long wanted to include this graph in a post. It’s from Howard Marks’ wonderful investing book The Most Important Thing:

The right way to think about risk.

Source: The Most Important Thing.

What this graph shows us is that expected returns do indeed increase with risk – but there’s a range of potential outcomes along the way. Some are dire. Plenty are bad.

It is a good graph to sear into your brain.

This graph is why most people are advised to use widely diversified stock funds, not try to find the next Amazon or Facebook.

It is the reason to hold some money in cash or bonds even when savings accounts pay you nothing and bond yields are negative.

It’s why we stay should humble and diversify our portfolios across asset classes, even ten years into a bull market. (Or make that especially ten years in…)

As with many things, expect the best outcome when investing – but be prepared for the worst.

1. I first heard it from Elroy Dimson of the London Business School.

from Monevator http://monevator.com/taking-more-risk-does-not-guarantee-more-reward/

Weekend reading: Are we there yet?

What caught my eye this week.

Are US markets enjoying a bull run of unprecedented longevity? You might think that could be answered by looking at a graph of long-term stock market gains, but the topic is surprisingly controversial.

Michael Batnick explored the debate this week, if you like that kind of thing.

Now, no offence to Michael but my favourite part of his post was this quote from Adam Smith’s classic book, Supermoney.

Here’s how he describes the late stages of a bull market:

We are all at a wonderful ball where the champagne sparkles in every glass and soft laughter falls upon the summer air.

We know, by the rules, that at some moment, the Black Horseman will come shattering through the great terrace doors, wreaking vengeance and scattering the survivors.

Those who leave early are saved, but the ball is so splendid no one wants to leave while there is still time, so that everyone keeps asking “What time is it? What time is it?”

But none of the clocks have any hands.

Wonderful. (Or, as a blogger, ‘well jel’, as the Majorcans would apparently say.)

In a variation on this end of days theme, Vanguard also wrote this week on why it is so hard to predict the next bear market.

But that article’s title misstates reality.

It’s actually very easy to predict a bear market. We’ve seen dozens of high-profile pundits make exactly that prediction over the past decade.

What’s hard is to be right!

Have a great weekend (and praise be to the rain.)

From Monevator

Average active funds have no answer to their weightless index tracking rivals – Monevator

From the archive-ator: A quick guide to asset classes – Monevator

News

Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!¹

UK interest rates will stay low for 20 years says outgoing MPC member – Guardian

Home equity release may cost pension firms billions – BBC

How one ‘push’ from bank fraudsters can lose you thousands of pounds [Search result] – FT

Pound dives to lowest level against dollar since June 2017 amid Brexit woes – ThisIsMoney

Nationalist president of Turkey appeals to ‘the people’ to halt FX slide – Bloomberg via Twitter

Indices are up, but beneath the surface the US stock market is shrinking – New York Times

Royal Mint estimates £170m of old-style pound coins are still unaccounted for – ThisIsMoney

Pension ‘dippers’ face tax relief shock [Search result] – FT

(Click to enlarge)

Cities house-price index suggests the property market is slowing – The Economist

Products and services

Is a 95% mortgage a better option than Help to Buy? – ThisIsMoney

Only one in 10 banks have passed on any of the interest rate rise. What to do? – ThisIsMoney

Beaufort Securities investors to access trapped funds “in a few weeks” – CityWire

Ratesetter will pay you £100 [and me a cash bonus] if you invest £1,000 with them for a year – Ratesetter

Trading apps expose consumers to cyber criminals, report finds [US but relevant] – Bloomberg

Investors charged hundreds of pounds for Isa and Sipp exit fees [Search result] – FT

New mortgage by L&G enables cash-strapped pensioners to refurbish housing – ThisIsMoney

Comment and opinion

The first rule of Financial Independence club – 3652 Days

How diversification feels in practice [Graphic] (h/t A.R.) – Dan Egan on Twitter

Swedroe: Latest data showing persistent out-performance is super rare – ETF.com

Why investors should care about rising interest rates – The Value Perspective

New favourite word: No – The Humble Dollar

The layers of the brain, and how it impacts investing – A Wealth of Common Sense

From emotional to financial, with finances and fitness – Get Rich Slowly

Something for a market (or a mid-life) crisis – A Teachable Moment

Thoughts on the upcoming pension costs and transparency inquiry – YoungFIGuy

How to manage a portfolio of shares – UK Value Investor

Elon Musk has some fun with Tesla – Bloomberg

Tips for aspiring professional portfolio managers – Enterprising Investor

Kindle book bargains

Liar’s Poker: From the author of the Big Short by Michael Lewis – £0.99 on Kindle

Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler – £1.99 on Kindle

Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven Levitt & Steven Dubner – £1.99 on Kindle

PostCapitalism: A Guide to Our Future by Paul Mason – £0.99 on Kindle

Brexit

Britain’s populist revolt [Long but thought-provoking read] – Quillette

How the young and old would vote on Brexit now – BBC

Off our beat

From East London to a City job: Knocking door’s changed this boy’s life [Video] – BBC

Natural maniacs [On Elon Musk] – Morgan Housel

You’ll be alright – Casey Mullooly

And finally…

“Workers work hard enough to not be fired, and owners pay just enough so that workers won’t quit.”
– Robert T. Kiyosaki, Rich Dad, Poor Dad

Like these links? Subscribe to get them every Friday!

1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.

from Monevator http://monevator.com/weekend-reading-are-we-there-yet/

Average active funds have no answer to their weightless index tracking rivals

War! What’s it good for? How about reducing fees to nothing?

Yes, fund giant Fidelity is now offering North American investors a US total market equity index tracking fund and an international equity tracker fund with fees of 0%.

While many still complain the markets are rigged and that small investors get a rotten deal, Americans who do their research can now invest for free.

So is this it? Investing nirvana?

Not quite.

Firstly these funds are for US consumers – and British investors still seem to pay higher fund fees than US investors in general. That said, even we can get cheap index trackers costing 0.1% or less a year.

Cost-wise, going from there to zero isn’t as big a leap as ditching an expensive active fund charging 1% or more. The big wins have already been achieved.

More subtly, as my co-blogger The Accumulator likes to say even cheapskate passive investors know someone has to be paid somewhere. So what’s the catch?

I see two potential wrinkles.

Firstly, the new 0% funds track Fidelity’s own in-house indices, rather than indices from one of the benchmark behemoths. This will save them paying licensing fees to the likes of MSCI or FTSE, but many investors would prefer index homogeneity across the tracker fund universe.

Second, the 0% funds will probably lend shares to short-sellers for a fee, which Fidelity will pocket. Some feel this practice sees a fund’s investors taking the risk but the manager getting the reward.

Neither wrinkle would stop me investing.

All indices are constructs and I expect a company of Fidelity’s standing has put together something reasonable. (We’ll look into this in the future).

As for the stock lending, defaults on security loans in such circumstances are rare, and should be covered by collateral. The Accumulator has previously expressed concerns though, and it’s true stock lending does add counter-party and related collateral risk to what ‘should’ be a simple fund.

You’ll pay (or not!) your money and take your choice.

Heroes and zeros

One thing not to worry about is Fidelity’s bottom line. The firm achieves roughly $18bn in annual revenues. Most of that comes from managing retirement accounts, active funds, and share trading, not from trackers.

When we last did a roundup, the cheapest world equity index fund for UK retail investors was already from Fidelity, charging just 0.13%. But apparently they offer US investors an equivalent charging just a tenth of that!

Going from such low fees to zero won’t upset Fidelity’s business model anytime soon. Rather, the zero percent funds are a loss leader, like our free current bank accounts. The firm will aim to make the money up elsewhere.

It will also cause headaches for rivals such as Vanguard and Blackrock. These index fund giants are less able to go to zero without scything their revenues.

The future of active management

Eventually I think we’ll see an index fund that charges a negative fee.

That’s right – you’ll be paid to invest!

A fund would achieve this by passing on those stock lending fees to its investors. It’ll probably be a gimmick rather than mainstream, but what a powerful signal it would send.

Sometimes I have to pinch myself. I’m not that old, yet even I can remember when the standard way to invest was to pay an advisor a trail commission of say 0.5% a year forever for putting you into an active fund that charged 2% a year. As if that wasn’t enough, you also paid 3-5% as a one-off upfront fee for the privilege.

There are protection rackets with better terms than that.

No wonder we’ve seen a huge shift to passive investing. Active investing is a zero-sum game, so pound for pound, by charging higher fees the average active fund can only lose by comparison. Simple mathematics guarantees that while there may be a few market beaters, the majority will under-perform – just as the evidence confirms.

For the average edge-less investor (that is, nearly everyone) index funds offer the cheapest, simplest, and most likely path to investing wealth.

Of course, as more people understand this, the financial services industry tries to obfuscate the truth to protect its cash cows.

We’ve all read the articles that misunderstand how passive investing works and blame it on every market evil under the sun – from flash crashes to low returns to high volatility to job losses to, well, giving a toehold for Marxism on Wall Street.

More constructively, some have advanced theories as to how active funds can turn back the indexing hoards.

But these generally fail a quick inspection:

• Some say active funds must work harder to earn their higher fees. But active investing is a zero sum game. Tens of thousands of smart people are already busting their guts. Everyone works harder, pays more, and on a market wide level the under-performance will persist.

• Active investing should be the preserve of specialist hedge funds, say others. They overlook the fact that hedge funds as a group have delivered worse returns than a cheap 60/40 passive portfolio for more than a decade. And with over $3 trillion under management they’re no longer niche.

• Just wait for a crash! Then active funds will prove themselves over dumb index funds that will follow the market down! This overlooks the fact that active funds are the market. (Did someone say zero sum game?) Falling markets are caused by active funds selling shares, or at least being prepared to pay less for them. Where active funds do better in falling markets it’s typically because they always hold a wodge of cash ready for client withdrawals, not because of skill. Cash keeps its value. You can mimic this brilliant strategy by keeping some money in a High Street savings account, and save on the fund fees.

• A few optimistic people say the industry as a whole should pay for the price discovery service that active managers perform, which index trackers exploit for free. As long as active managers are the ones driving around in sports cars there’s zero chance of that happening.

• Some say active investing needs to be reinvented through simple Factor Investing / Smart Beta / Return Premium funds. These enable investors to buy into something supposedly more concrete than ‘magical’ manager skill. A retort is that factors may not persist – our own contributor Lars Kroijer is one skeptic.

That last is already happening, anyway, through the proliferation of factor-based ETFs. Their undeniable advantage versus traditional active funds (though not the cheapest market-weighted trackers) is they’re less expensive to run.

Computers don’t demand sports cars!

Active funds must cut costs to compete with zero

I believe that cost cutting is the only way that active funds can compete long-term.

The reason active funds do so poorly as a category is that in a zero-sum game, their high fees gnaw away at their returns.

Before costs are taken into account, there is a share of money in active funds that does beat the market – which is balanced by an equal weight that loses.

The net result is the market return (which is captured most cheaply and consistently by passive funds).

If active fund managers leveraged technology to cut costs across their businesses, they might be able to reduce their total expense ratios to best-in-breed pricing of say 0.3% or less.

That would still be two to three times as expensive as a decent equivalent index fund (let alone a free one) but at least it’d be competitive.

Many people seem to believe they deserve to beat the market. And they like humans managing their money more than machines. Passive investing feels wrong. That’s why the active industry persists.

If active funds were much cheaper, these notions wouldn’t be so consequential, and the case for choosing a tracker over a ‘fun’ flutter on a flavour-of-the-month manager would be weakened.

I don’t say that it would be logical for the average investor to then choose active – they’d still on average lose to the market. But it’d be much less potentially damaging.

Slashing costs – that’s the only proper way for active to compete long-term.

Actively foolish

The industry though continues to prefer an alternative route of spreading fear and confusion to try to salt the earth for passive funds.

Just last week saw another doozy in the Financial Times.

The article – Passive Investing Is Story Up Trouble¹ – took a machine gun to modern markets. Albeit a machine gun filled loaded ping pong balls.

The result was a lot of random seeming attacks bouncing everywhere and missing their target.

The piece attacks robot traders for their supposedly indiscriminate – or at least business-agnostic buying – before strangely conflating their activities with passive investing.

Investors in index funds and ETFs are also lamentably clueless, the author implies, pushing up the most popular stocks with their relentless buying.

Never mind that many a robot’s algorithmic strategy is focused on company fundamentals, via the factor investing I mentioned above.

And never mind that – for the gazillionth time – money that flows into the big market-cap weighted funds does not in itself distort prices. That’s not how it works!

Market cap weighted index funds follow the prices set by active investors.²

Anyway, even the allegedly witless robot traders who follow price signals are not just waving their steely fingers in their air. Prices contain information, whether it’s a shortage of cocoa that pushes up the price of chocolate bars or a surplus of some high-flying tech stock that people want to dump after a terrible trading update. A robot trader’s algorithm is not ‘think of a number between one and a hundred and pay it’.

But perhaps the biggest laugh is the implication that passive investing and automated trading has brought imminent ruin to a previously calm money-making oasis.

Stock markets boomed and blew up for a hundred years fine without index funds or robot traders. Flash crashes are dramatic and unsettling, but they last a couple of hours – manias and funks driven by human emotions can persist for decades.

If the big gains we’ve seen for US tech giants like Apple, Alphabet, and Amazon are priming the stock markets for an imminent rout (and I don’t think they are, incidentally) then it will be because active investors set too high a price for those shares – not because passive money dispassionately followed it.

And when the dust settles after the next crash – and there will be a next crash – we’ll see how well these active gurus sidestepped the alleged silliness they see today.

Perhaps a bevvy of skeptical active funds will smash the market and vindicate their high fees?

I wouldn’t hold your breath.

1. [Search result]
2. The one quirk is when a company enters or leaves an index that is being tracked, there can be a price impact from passive fund trading and those who anticipate it. But that is a one-time event, is rarely what’s being attacked, and the overall affect is relatively small.

from Monevator http://monevator.com/average-active-funds-have-no-answer-to-their-weightless-index-tracking-rivals/

How technology has changed our relationship with money

One of the important things everyone has to think about in life is money. Although it might not make the world go around you still need it to survive. From getting a job to earn some money, to how you keep it safe and spend it, money is something we all have to consider on a daily basis.

The world of money is one that has been greatly affected by the evolution of technology in recent times. As with most areas in modern society, technology has not only changed our relationship with it but also how we deal with it. Gone are the days of having to carry around bundles of paper money to spend or calling into the local bank to pay some into your savings account.

Technology has had a major impact on money

Whether you are based in Manchester or elsewhere in the UK, you will have seen this change yourself over the years. Here are some of the main ways in which technology has changed how we now deal with our money.

• Sending and receiving money – in years gone by, to send money to someone who lived far away meant putting physical money in a card or envelope to post off to them. To receive money would mean someone doing the same to post it to you. That was slow and not very secure. Technology has changed that by making it possible to send and receive payments online via online money transfer companies. Being able to send money online in this way is much quicker and more secure.
• Mobile banking – a big change seen in our relationship with money is the rise of online mobile banking. It allows you to use your connected mobile device to pay for goods, shop online and send money to friends. This has made dealing with your money much more convenient.
• Online banking – mobile banking is only possible because of the invention of online banking. That advance was one of the real game-changers in how we deal with our money on a regular basis. It removes the need to visit your local bank in person and makes it much easier to check your balance and transfer money between your accounts.
• Electronic payment solutions – online giants in this area of money include PayPal, that has millions of users and is still growing fast. These solutions, along with contactless debit cards, have practically eliminated the need to carry paper money. Instead you can pay for what you need either with a piece of plastic in the form of your debit card or online with the purely electronic payment options.

Our relationship with money has changed

When you compare how we now deal with money and how we look after our finances then it is clear to see that it has changed a lot. In general, it has been a good thing because it has made dealing with money much more convenient, more secure and easier. Compared to having to go into the bank when it was open to check your balance or to pay money into an account, the modern methods are much better.

 

from Finance Girl http://www.financegirl.co.uk/how-technology-has-changed-our-relationship-with-money/

Weekend reading: How high should interest rates really be?

What caught my eye this week.

The Bank of England is hellbent on crashing the economy, having recklessly raised interest rates by 0.25% to 0.75% this week.

No, that’s not my opinion. But it was a view sounded by many commentators in the wake of Bank Rate rising above 0.5% for the first time in a decade. Critics even included one former Bank Rate setter.

Really? Let’s remember that with inflation running at well over 2%, we still have a strongly negative real interest rate. (‘Real’ means inflation-adjusted, remember).

In real terms, even after this latest rise Bank Rate is still MINUS 1.55%.

And that’s before we take into account the impact of all those rounds of quantitative easing, the point of which was to effectively lower real interest rates in the market.

Money remains historically very cheap.

Borrowers still blessed

It’s true that several million people on variable rate, tracker, and discount mortgages will see their monthly payments inch up a tad.

But many such homeowners have seen their mortgages being paid off by a decade of negative interest rates. For all the austerity felt by the poor, it’s been a super time to be a middle-class homeowner. Few should complain too loudly about a 0.25% rate rise.

On the flip side, some of the rate rise will be passed on to savers, though as we slowly return to something like normal rates we should expect this to lag.

UK banks never took the interest rates paid to ordinary savers below 0% in the financial crisis. Instead there was a compression of the spread of rates that banks usually profit from. This will have to be unwound, and so I expect savings rates to rise more slowly than mortgage rates.

Personally, I’m inclined to think that if the economy cannot take a slightly less negative real interest rate – fully ten years after the financial crisis and with employment and with house prices at an all-time high – than we ought to find out sooner rather than later, as opposed to speculating.

Star power

With the rate rise expected by everyone, perhaps the more interesting thing to come out of the Bank was an estimate what its wonks call r*. (Pronounced “r-star”).

r* is shorthand for the ‘equilibrium real interest rate’ – and if you think that mouthful is reason enough for the shorthand, wait until you hear the long definition:

The ‘equilibrium interest rate’ is the interest rate that, if the economy starts from a position with no output gap and inflation at the target, would sustain output at potential and inflation at the target.

Okay, perhaps that’s not too confusing. But then I have been reading the Bank’s deliberations for the past couple of hours, so perhaps I’m inured to banker-speak.

You can get up-to-speed on r* for yourself by reading pages 39-43 of the newly-published Inflation Report [PDF].

Basically r* is the Goldilocks interest rate – neither too hot (that is, a rate that’s too low) to stoke the economy and push up inflation, nor too cold (er, a rate that’s too temptingly high) to incentivize savers to move their money out to work fueling the engines of capitalism, as opposed to leaving it all sitting in a bank in cash.

Unfortunately, there’s no way of knowing exactly what r* is at any particular time.

Instead, policymakers have to infer it, in the same way that you have to try to figure out if he or she is really in love with you.

Various factors may weigh down – or boost – the equilibrium real interest rate. In the medium to long-term though there’s presumed to be an underlying trend rate – confusingly also called R*, though note the capital – which is where real interest rates could sit if the economy never fluctuated and Bank officials could spend their time at the beach instead.

Sadly in the real world, things do impact the rate – an impact that the Bank labels s* (where the ‘s’ supposedly stands for short-term but which I think stands for shit stuff happens.)

When s* would heat things up, r* would need to be higher than it otherwise would be (R*).

When s* is a drag, r* would need to be lower.

Right now the Bank believes we’re still in a sticky patch for ‘stuff happening’, what with the Brexit uncertainty, talk of trade wars, the lingering impact of the financial crisis, and also perhaps rates around the developed world being similarly measly.

This belief that r* is low is why Carney and Co. have been keeping Bank Rate so low, and why the Bank is raising rates so slowly.

The Bank’s assessment is that R* would be too high a Bank Rate to keep inflation on target at 2%, given the headwinds.

It believes r* is lower, and hence we still get low interest rates.

R-stars in their eyes

If you’re not asleep by now, no doubt you’re screaming: “Great, but what should R* be! Surely that’s the important bit!”

You’re right, like the Bank of England I’ve deliberately buried the lead.

After stressing that its best guess is just that, the Bank estimates that R* – the long-term trend real equilibrium rate, you’ll recall – is currently somewhere between 0%-1%.

What’s more, it estimates R* has plunged from around 2.25%-3.25% back in 1990!

This is all hugely significant.

Remember, R* is a real interest rate. Add the 2% inflation target onto it, and we get to where the Bank Rate would be in a perfect world (to over-simplify).

What the Bank is estimating is that absent those short-term / stuff happens factors, Bank Rate would now be at between 2-3% (as opposed to 0.75%).

In contrast, if R* was still where it was in 1990, the equivalent ‘normal’ Bank Rate would be 4.25-5.25%.

Clearly this has big implications for both savers and borrowers.

It suggests anyone waiting to get 5% – or even 3% – in a standard savings account shouldn’t hold their breath.

Similarly, mortgage holders shouldn’t have too many sleepless nights worrying about rates leaping back up to 5-7%, at least on current forecasts.

Playing for ratings

Of course if R* can come down then it can go up again.

The Bank thinks that the aging population, slower productivity growth, and the impact of more cautious financial regulation has likely pulled down R*.

Set against that, it believes the requirements of younger foreign savers and even the rise of the robots could affect R* in the future.

But it doesn’t expect anything to happen very quickly, to either r* or R*.

Absent some huge shock such as a Hard Brexit or a surprise election-related run on the pound, the bottom line is interest rates aren’t going much higher anytime soon.

From Monevator

How to open an online broker account and start investing – Monevator

From the archive-ator: They don’t tax free time – Monevator

News

Note: Some links are Google search results – in PC/desktop view you can click to read the piece without being a paid subscriber. Try privacy/incognito mode to avoid cookies. Consider subscribing if you read them a lot!¹

Bank of England raises UK interest rate to 0.75% – BBC

Five things we learned from the Bank of England’s deliberations – BBC

UK house prices hit new record average high of £217,000 – ThisIsMoney

Job-switching workers enjoy fastest pay growth in a decade – Guardian

Inheritance tax hits record high: What are the thresholds? – The Week

Interesting series of graphs show how America divvies up its land – Bloomberg

Products and services

It’s happened: Fidelity unveils the first no-fee index funds (in US) – Investment Week

Yorkshire Building Society offers 10-year mortgage fix at just 2.49% – ThisIsMoney

Savings banks and mortgage lenders react to the rate rise [Search result] – FT

Got £1,000 spare? Ratesetter will pay you £100 [and me a cash bonus] if you invest it with them for a year – Ratesetter

George Soros-backed firm unveils superfast broadband rollout in UK – Guardian

Online shoppers to face extra security check, via smartphone [Search result] – FT

What to do if HMRC makes a so-called emergency tax raid on your pension cash – ThisIsMoney

Comment and opinion

Charley Ellis: Indexing and its alternatives [Podcast] – Capital Allocators

Willing losers – A Wealth of Common Sense

Four lessons from the richest woman in Wall Street history – Of Dollars and Data

The (other) problem with active fund management – Behavioral Investment

How to make your child a pension millionaire by 43 – ThisIsMoney

Why even winning investors and tennis stars often feel like they’re losing – The Value Perspective

Last Chance U and financial independence – Young FI Guy

Be rich, not famous: The joy of being a nobody – Financial Samurai

Farmland as an asset class [Podcast] – Meb Faber

The top 1%, corporate version – Morningstar

Blockchain hype is fading fast – Streetwise Professor

The role of shorting stocks in delivering factor² returns [Geeky] – Factor Research

You still benefit from global equity diversification, but less so nowadays for bonds [Research] – SSRN

Kindle book bargains

Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler – £1.99 on Kindle

Liar’s Poker: From the author of the Big Short by Michael Lewis – £0.99 on Kindle

Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven Levitt & Steven Dubner – £1.99 on Kindle

PostCapitalism: A Guide to Our Future by Paul Mason – £0.99 on Kindle

Brexit

What would a No Deal Brexit mean for your finances? [Search result] – FT

Carney: No-deal Brexit risk ‘uncomfortably high’ – BBC

London Stock Exchange has triggered its No Deal contingency plan – Business Insider

Not drinking bleach is ‘Project Fear’ says Brexiteer – The Daily Mash

Off our beat

No, you probably don’t have a book in you – The Outline

SpaceX’s secret weapon is Gwynne Shotwell – Bloomberg

The sadness of deleting your old Tweets – Wired

Goop’s haters made Gwyneth Paltrow’s company worth $250 million – New York Times

How Silicon Valley became a den of spies – Politico

The death of the author and the end of empathy – Quillette

And finally…

“The grim irony of investing, then, is that we investors as a group not only don’t get what we pay for, we get precisely what we don’t pay for. So if we pay for nothing, we get everything.”
– John Bogle, The Little Book of Common Sense Investing

Like these links? Subscribe to get them every Friday!

1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.
2. Aka Smart Beta.

from Monevator http://monevator.com/r-star-trend-interest-rate/

Forex vs Cryptocurrency Trading: Investment Comparison

In the past, people willing to invest would either buy an equity in a local company or find a stock market broker in order to invest in a corporation. Nowadays, however, there are many other ‘standard’ choices that are rapidly gaining in popularity. With the rise of Bitcoin in 2017, more and more people are interested in buying cryptocurrencies. On the other hand, with so many online forex brokers, it has never been easier to become a forex trader. All in all, both of these methods of making money have their advantages and disadvantages.

Starting out

Even though it is quite easy to start on any of these two paths, the truth is that starting out the right way is not as easy as you might have thought. In order to make data-driven decisions instead of plain guessing, you need to get a grip on things that you’ve never handled before. So, you need to start educating yourself on these topics and, in order to do this, you need to have access to various reliable sources. For starters, you should start following reputable cryptocurrency news sites and learning a thing or two about forex trading features.

When it comes to the comparison of the two, it is arguably easier to grasp the forex market, seeing as how it requires you to acquire a lot less technical knowledge. Sure, one may argue that even people with little to no knowledge of the blockchain technology have managed to make a fortune in the world of cryptocurrencies, yet, relying on luck instead of knowledge is a gamble and not an investment. Ideally, you could find a mentor. Someone with enough experience in these fields in order to break down some of the most important industry-relevant information.

The potential for profit

The first thing that comes to mind when speaking about any investment is a profit potential. When investing in cryptocurrencies, a lot of people hope to discover a rising coin while it’s still cheap and then keep it until its price skyrockets. In this way, investing in cryptocurrency would be able to bring you an incredible ROI, seeing as how you could start with modest means and eventually amass a fortune.

A similar thing is applicable to the forex market, as well. One of the greatest misconceptions about this market is that you need to have a fortune in order to make noticeable gains. People claiming that clearly have a superficial knowledge of the forex trading in general. Latest forex platform allows you to use forex leverage, which means that you can work with figures 500 times greater than what you’ve invested.

Position vs. day-trading

Another massive difference between forex trading and cryptocurrency trading lies in the strategy you decide to adopt. You see, forex market is highly volatile, which is why a lot of people decide to go for day-trading instead of position trading. Apart from the danger (or loss of sleep) that comes from leaving your investment in the air overnight, most day-trading losses end at 1% of your total account value, while even the most successful trades end at about 6%. In other words, you depend on a huge number of smaller transactions and might remain profitable even with only 30%  of successful trades.

While there are people who dynamically trade cryptocurrencies, there is also a general consensus claiming that in order to really make a splash in this world, you have to A) recognize a growing coin and B) wait for its value to skyrocket. As you can see, this is much closer to position trading. Of course, we have to stress that there are a lot of people out there who day-trade cryptocurrencies and position trade on the forex market.

The ICO phenomenon

The next trend that makes people fall in love with the idea of cryptocurrency trading is the ICO (Initial Coin Offering) phenomenon. This is a high-risk-high-reward scenario in which you discover a cryptocurrency in its infancy and trade your more regulated coins (Bitcoin, Ethereum, Ripple) in exchange for great quantities of this coin. If the coin in question makes it through, you stand to win an amazing ROI. There are reliable sources of blockchain news ,that offer good information about the ICO investments and newest blockchain technologies on the market, so make sure to do some research before anything else.

Diversifying your portfolio

At the end of the day, we already discussed that both cryptocurrencies and forex market allow you to start out with relatively modest funds, which is why there’s no real reason for you not to pursue both. If you don’t trust both of these trends to the same degree, there’s no reason for you to invest in them 50/50. Instead, you can allocate at least a minor part of your assets to the other trend. This helps you diversify your portfolio and, consequently, make it substantially safer.

Conclusion

The last thing you need to keep in mind is that the money you stand to invest does have a potential of making some money on its own, and yet no investment is 100 percent safe. Therefore, do not dip into your emergency savings account or your 401K. As we have already stated, you should only trade with the money you can afford to lose.

from Finance Girl http://www.financegirl.co.uk/forex-vs-cryptocurrency-trading-investment-comparison/