I think back to 2007 when I first realised that for the first 12 years of my life I had been working for everybody but myself. And if I didn't start taking responsibility for my own future quickly I was going to end up with little more than a State Pension (or some other form of welfare) that would be provided at an age chosen by the government of the time. I needed to start saving and investing without further delay.
I did what the mainstream world tells us all to do. I spoke with Financial Planners who I believe in hindsight were making what they were offering sound more complicated than it needed to be. I also read about what looked like complex investment products which would not only give me a fantastic return but would in some instances possibly even put man on the moon. I'm possibly even guilty of it when I talk about my own low charge strategy and some of the other concepts we cover on this site. I think it’s a simple concept but thinking back to what I knew when I first started down this road it would have been nothing short of confusing. Of course the difference is that I don’t get wealthy at your expense. I'm not for a minute suggesting that there is anything illegal or misleading going on but I am glad that I went DIY as I believe that I would have had no better return plus I've saved on all the fees and expenses which are now part of my wealth which is compounding nicely.
Since going DIY I am happy with progress however one area I know I went wrong is during the first couple of years when I knew nothing and was trying to learn. This period of time definitely cost me and while I don’t regret it as it taught me what I know today, thinking back I really should have just used the KISS rule until I’d educated myself. So let’s do that today and try and build a simple portfolio and strategy which could maybe tide a DIY investing beginner over until they were ready for more complexity. When they are finally ready they probably won’t even have to sell but instead could just build upon what would then be a core holding and if they were never ready then they’d still likely do ok.
The Building Blocks of the PortfolioAs I've already mentioned above there are a myriad of investment options however Tim Hale’s excellent book tells us that there are only two central building blocks – equities and bonds - which complement each other. To quote Hale, “equities have an economic rationale for and history of delivering mid-digit real returns (after inflation) and are considered the engines of portfolio returns, but with considerable and sometimes extreme swings in returns – at times leaving investors with large holes in their wealth. High quality domestic bonds on the other hand, tend to have far smoother returns at a cost of lower returns, which come in the low single digits, after inflation.” ”Mixing them in different proportions creates a good range of portfolios.”
We’re trying to create a simple portfolio so we’ll let our investor go no further than a portfolio of equities and high quality domestic bonds. Now we need to determine how they should be mixed which is known as asset allocation. Again, let’s keep it simple and use the rule of thumb that you should hold roughly your age in bonds. It’s a rule of thumb which is also recommended by John Bogle so comes with some credence. If our beginner turns out to be a conservative investor then it probably has them holding too many equities and if they end up an aggressive investor then too many bonds but this is supposed to be simple so we’ll go no further.
What equities should our beginning investor be buying? Again I’m going to keep it simple and suggest the FTSE 100. It’s only 100 companies but it represents about 81% of the UK market and gives international diversity with around 80% of all earnings coming from overseas. What about high quality domestic bonds? Here I'm suggesting the safest domestic bond type for UK Investors - UK Government Gilts.
So that’s the simple portfolio for our investor – our beginner’s age in UK Government Gilts and 100 minus our beginner’s age in the FTSE100. Now if our investor wants to maximise their return from this portfolio they must minimise expenses and taxes.
Minimising Portfolio ExpensesThere are many FTSE100 trackers out there but the cheapest I’ve been able to find is the Vanguard FTSE100 ETF with a Total Expense Ratio (TER) of 0.1%. For the UK Government Gilts let’s stay with Vanguard with our investor buying the Vanguard UK Government Bond ETF with a TER of 0.12%. So if our investing beginner was 35 years of age their total expenses are a low 0.107% per annum.
Minimising Share Provider Expenses and TaxesOur investor now needs to buy these ETF’s through a share dealing provider. They should also now be now preventing HM Revenue & Customs from getting their hands on as much of the portfolio as possible.
If they are investing after tax £’s then they need look no further than an online Stocks & Shares ISA wrapper. There may be others but a suitable ISA for minimising expenses could be the TD Trading ISA from TD Direct. Providing our investor has an ISA balance of £5,100 or more there are no annual fees. The only thing to watch out for will be each time an online purchase is made, which will be either the initial ETF purchases or any subsequent regular investment, a trading commission of £12.50 will apply. The trick to minimising trading commission impact is don’t tinker and buy in reasonably big chunks. I’d suggest save in cash until you have at least £2,000 and then make a trade.
If they are investing pre-tax £’s, which might come from say movement of a Pension pot from an expensive Insurance Company, then they’ll be likely looking for a low cost SIPP provider. Again there might be others but they probably wouldn't have to go much further than a Sippdeal SIPP. Hold only those 2 ETF’s and there are going to be no annual charges. Only purchases will again attract a trading commission. This time it’s £9.95 per deal for the first 9 deals in the month.
Rebalancing the PortfolioOur investor now has a simple portfolio, with the lowest expenses I see possible and within the lowest tax framework I can see as being possible for this portfolio. The final consideration is what to do when the portfolio allocation moves away from the age in bonds asset allocation with time. Again let’s keep it simple.
Firstly, as new money enters the portfolio through savings our investor should just buy the ETF that is performing the worst. Do the same with all the dividends. If after both of those actions the asset allocation ever moves 5% away from the age in bonds target (for example a 40 year old ends up with 65% in equities) then sell the best performing ETF and buy the worst performing to rebalance.
ConclusionI’m the first to admit that this 2 ETF Portfolio is unlikely to put our beginner DIY investor on the Efficient Frontier but what it does do is give a DIY beginner a fighting chance of a reasonable return during the early days. In parallel to running this portfolio they can then educate themselves through their own private research, make up their own minds and I believe when they look back in a few years at how their DIY investment journey started probably wouldn't think they went too far wrong. Who knows, some might even decide to not make it any more complicated.
Do you agree? Do you have a better idea for a Simple Low Expense, Low Tax Investment Portfolio for DIY Beginners?
As always DYOR.