Vanilla in a nutshell

The personal finance industry is a drain on resources: yours.  Vanilla Finance came about as a way of saying to us ordinary punters: this is what you need to know and its not a bad plan [maybe not the best, but that is unknowable in advance].

Vanilla Finance says 

1 Own asset classes, rather than individual shares or loan stock. Passive investing.
2 Over a lifetime of saving, your asset allocation determines your outcome.
3 Work out an allocation that suits you, and stick with it unless your circumstances change.

Just as dieting can be summed up in a few words [eat less, exercise more], so can vanilla finance [index and rebalance]. Like dieting it can be hard to stick to the rules. Unlike dieting it gets easier the lazier you get. Rebalancing is the most active part, and that can be left for years [every two or three years still seems to work as well as anything].

Implicit in this approach is that professional managers [eg unit trusts] do not add value [some do, some don't, but you don't know which in advance].

Figures in the landscape
When I give examples I mostly use real [not nominal returns]; I also assume 1.5% advisor charges with funds, but only 0.5% with trackers and etfs. Benchmark returns [ie 'what if', not predictions] are 1% for gilts, 2.5% for corporate bonds, 4% for equities; an equity risk premium of 3% [until recently that was the on low side of the consensus]. They also give handy doubling times of 70, 30 and 18years which have a very human scale to them.

As befits vanilla simplicity I only have two asset uber classes. Boring and bouncy. Boring has reliable returns, 'bouncy' doesn't. Index-linked gilts, and shares are examples of each. 

In the simplest version of vanilla 'boring' contains' 3  asset classes: cash, short-term gilts, and index-linked gilts.  Bouncy contains: shares, overseas shares and commercial property.

Other asset classes, like private equity or timber turn up later; hedge funds never show up. Commodities have been shown the door but keep trying to climb back in through the window.

So the big decision comes down to the mix between boring and bouncy in your asset allocation. 

If you only make one decision in your investing life, this should be it. Once you have made it the rest is detail.

It's like mixing a cocktail. How much from the boring bottle - and how much from the fizzing bubbling bottle that hints at the promise of riches to come? A bit of fizz can be more fun, but it can also give you a headache in the morning [or worse, 40 years later on retirement].  The sheer weight of responsibility might make you hesitate before mixing up this cocktail of assets for your lifetime - but in fact you will have already done it. You have an asset allocation right now, its just you haven't checked out what it is.  The variations are practically endless - but vanilla suggests 3, as yet unamed, benchmark cocktails: 

adventurous 2:1; balanced 1:1 or cautious 1:3.

Note even the most adventurous allocation only has 67% 'bouncy' -  far short of 100% equities, and certainly nothing over 100% [which would be leverage with a loan]. The cautious cocktail has 75% in cash and gilts - once upon a time this was thought suitable for a 75year old...

So finally we get there: mixing up first a balanced cocktail we have 50/50:

20% gilts, 20% index linked gilts, 10% cash - the boring bit
20% shares, 20% overseas shares, 10% commercial property - the bouncy bit

There's enough of a kick from the 'bouncy' side to leave you a bit dizzy from recent market falls. And the strong hint of commercial property that added zest a few years ago, now just leaves a nasty taste in the mouth.

The cautious cocktail gives you

30% gilts, 30% index linked, 15% cash

10% shares, 10% overseas, 5% property

There's a hint of fizz and a lot of boredom. And right now boredom is in short supply.

You can get this coverage with trackers or etfs [eg ishares]. The contentious bit is there are no corporate bonds. Opinions differ as to whether they offer the best of both worlds or the worst. Vanilla is in the latter camp and recent events have confirmed it. Next year may be a great year for corporate bonds, but then it may be a great year for equities too.

Also overseas equities have a strong covariance [move in tune with] with domestic, so they ain't a great diversifier.  But as the pound has dropped overseas  holdings have been useful. Overall the 50/50 portfolio would have saved you from the worst excesses of the market slump.


So far, so what?

Well if you cut 1% off your charges, that makes a big difference. Chances are a disciplined approach will save you even more. Studies of what investors actually earn make for depressing reading. Money-weighted rates of return are very different from time-weighted. Money-weighted is the one you eat.  

Earning 100% on £50 is not much use. Next year you earn 0% having been encouraged to invest £50000. Your charts say you have earned a simple average of 50% a year. You would be the pin-up of the funds industry, maybe feature in their ads. But your spouse knows you have earned £50 over two years.

Also vanilla finance favours delaying paying into a pension fund until you can get a 40% rebate - and that might mean waiting until your 40s.

And last but not least vanilla finance says you can usefully use all your savings to pay down the mortgage - and forget the rest. Once the loans are off your back then you can start with the cocktails.