(Written by Jen Lincoln and Sebastien Aguilar)
We were in for a real treat last Saturday, November 12, in Dubai Media City. Hannah Matta, a personal finance enthusiast who joined us last summer when researching how to direct her investments. She then conducted a lecture and PowerPoint presentation on Bogleheads®, and similar, investment philosophies to put us all to shame.
Sebastien started with a welcoming introduction about the group. As always, we are clear that we are a non-profit community. "Common Sense Personal Finance and Investing - Bogleheads® UAE Chapter" does not offer professional advice, nor collect any fees (beside the few bucks for the projector we rented for this presentation). For those interested in connecting with Bogleheads® UAE, the official national chapter, there are many venues, including of course this website, the Facebook group, the mailing list, the Meetup page, the scheduled presentations, or by contacting one of the administrators. There is of course a wealth of investment information, including counseling on investment strategies from the international community, on the Bogleheads.org forum itself. Other popular resources which are not Bogleheads® but espouse similar philosophies include Mr Money Moustache, JL Collins, Investopedia, and a myriad of other resources.
Sebastien then reminded us about the Simple (Bogleheads®) Investment Principles. These in a nutshell include:
Diversify to lower risk (use index funds)
Keep costs low
Don’t try to time the market
Stay the Course
These philosophies are extensively explained on the Bogleheads® forum.
Hannah’s presentation included a planning strategy, the agenda of which included reflection on the following questions:
How much money will you need to retire?
How much should you save and invest?
How are you going to invest?
To figure out how much money will you need to retire/how much to save, we must look to the Safe Withdrawal Rate (here we are going with the standard 4%).
Hannah used the example of someone that needs $25,000 per year in income and plans on retiring in 25 years. After accounting for inflation (3.5%/y in this case), $25k/y becomes $59k/y in 25 years. To be able to withdraw this amount annually, the portfolio needs to be $1,477,025. From there, Hannah estimated the required annual investment to reach that amount in 25 years to be $25k (at an assumed 6% annual rate of return), or a little more than $2k per month.
For those interested in making the calculation for themselves, there is a compound interest calculator online at MoneyChimp.com.
So, how to get there? Assume that index fund investments pay 6-7%, and this amount will compound into your investment growth. One just has to decided how you are going to invest. This entered into a discussion on investment vehicles.
What are shares? What are bonds? Both are important vehicles for investment. For bonds, the one that is less known, there is an idea to stick to short-term bonds opposed to long-term bonds for a strategy where bonds provide stability. Generally speaking, short-term bonds pay less interest as they are seen as having less risk since your money is tied up for a shorter period of time.
Of course, no Bogleheads® meeting is complete without a discussion on Passive vs. Active Investment Funds. Bogleheads® favours passive investment for good reasons.
In the long term, active managed funds on average under-perform the index as no one can time the market. Even ‘professional’ active managers cannot figure out what companies are failing (whereas these companies just drop out of passive index funds). Meanwhile, fees for active managed funds will often cost the investor a large share of their profit.
Brokers own yachts for a reason, and it’s from the customer’s money.
Passive Investing rules can be summarized as follows:
Create your own portfolio
Ensure that you diversity
Keep costs low! Look for low transaction fees (<1%). Consider investing quarterly to keep transaction costs low.
Stay the Course
Re-balance: make sure you get back to your target asset allocation regularly.
Hannah then presented a few portfolio options.
She presented the Couch Potato Portfolio as the simplest way to diversify between a total stock index fund and a short term bond index fund: 50/50. This is simple and solid: it takes advantage of the diversification that exists within each of these funds (across markets and geographical regions) and supplements it with a diversification across the two selected asset classes.
Your nationality and where you intend to retire play an important role in designing your investment strategy, especially because of the tax and currency implications. Such questions are especially important for the expats in our UAE group. For example, in many cases for non-US nationals, it is better to purchase ETFs based in Ireland or Luxembourg rather than in the US because of the US tax on estate.
Hannah then discussed a variation of the Couch Potato Portfolio, where your age determines the percentage of bonds you hold in your portfolio. This is very much aligned with the Bogleheads Philosophy.
Rebalancing is also an important part of long-term portfolio planning. There are different ways to do this. One method is rebalancing once a year. Consider as follows:
Set a date (or else you’ll time the market!)
Incur transactions costs
‘Sell what’s hot and buy what’s not’ (effectively forcing you to buying low and selling high)
Another way to do it, a very traditional way, is to rebalance quarterly. Quarters are not necessarily the market quarter, but rather your family’s quarters, based on when you began investing. Top up poorly performing index funds each quarter, as conter-intuitive as it may seem.
Hannah introduced us to another example of portfolio: the Permanent Portfolio. Here you diversify across 4 asset classes as follows:
While this portfolio may appear unorthodox, it is particularly interesting for investors aiming at protecting their assets: secure a decent return while minimizing volatility. It is designed to protect your assets in economic prosperity, inflation, recession or deflation.
Another portfolio presented by Hannah is the Coach Potato with a Fundamental Twist. Traditional Index Funds are capitalization (Cap) weighted. So SP 500 contains 500 largest companies in the US, but not represented evenly. Instead, they are weighted in order of size of companies in the index, briefly:
Market Capitalization= Stock share price (Popularity) x total number of shares available (risk to diversification)
High market cap= more exposure in t he index
The bigger the business, the higher the influence of the index’s price level
Fundamental Analysis doesn’t look at size of profitability (uses book values, dividends and profitability) of companies in an index. Most profitable gets more exposure. Be careful of synthetic ETFs.
How to know what funds to buy? Initially, compare expense ratios between the options. Thereafter, read the facts on the fund. Past performance is a questionable way to judge a fund, but past performance is available to see. Diversified funds mitigate risks. There are also innumerable resources mentioned previously, as well as the general international Bogleheads forum where anyone can post about their situation and advice is sure to come in. There are many informed people out there in this community that are happy to help others.
We wish Hannah luck in setting up her portfolio and voyaging onwards in this journey. Outstanding presentation!
Notes from Sebastien:
More on Bogleheads® portfolio examples: Lazy Portfolios. Please note that these portfolios are mostly aimed at Americans. make sure that you adapt them to your situation.
Here you can find more information about how to implement the strategies we discuss if you live outside of the US.
More on Asset Classes
A great way to learn about investing in the stock market: JL Collins Stock Series
And here is Mr Money Mustache Recommendation on How to Make Money in the Stock Market.
Let us know if you need help!