Although I don’t think it’s a good idea to look at the value of your investments too often, I do think it’s a good idea to carry out regular but infrequent portfolio reviews.
In my case I do these reviews at the end of each quarter and, as you’ve probably guessed, this is the first quarterly review for 2018.
Every good portfolio review needs some targets, so here are the targets I’ve set for my defensive value portfolio.
- High growth: Higher total return (dividend income plus capital gain) than the FTSE All-Share over five years or more
- Achieved by: Investing primarily in high-growth companies
- High income: Higher dividend yield than the All-Share at all times
- Achieved by: Investing primarily in high-yield companies
- Low risk: 1) Smaller and shorter declines than the All-share and 2) positive returns over five-years
- Low effort: Spend only a few hours required each month managing the portfolio
- Achieved by: Making no more than one investment decision each month
Let’s have a look at growth first.
Higher growth? Yes, ahead of the market over the sort of time frame investors should care about
I’ve written before about why one-year returns are a terrible metric. They’re volatile, misleading and do little other than excite or worry investors unnecessarily.
The recent market correction is a good example of this.
In the grand scheme of things this “correction” is unbelievably irrelevant, yet it commands endless headlines from the financial media whose main purpose seems to be to terrify investors.
So if we make the mistake of looking at short-term performance then we see this:
This is the roller coaster of short-term stock market returns. Sometimes you’ll get 20% to 30% in a year and sometimes you lose 10% or more in a year. Sometimes you’ll beat the market by a country mile and sometimes the market will kick your backside.
Investors who focus on the short term have their nerves endlessly rattled by these ups and downs. That’s a shame because short-term returns are irrelevant, given that equity investments should be held for at least five years and preferably ten or more.
If we step back and look at returns over a slightly longer period, three years in this case, we get this:
The three-year returns chart is much more informative than the one-year returns chart.
We can see that my defensive value portfolio has beaten its All-Share benchmark over just about every three-year period ending somewhere between 2014 and 2018.
The only exception would be the three-year period ending September 2014, but that’s okay because you can’t expect to beat the market all the time, especially over a relatively short period like three years.
As well as three-year returns being less volatile than one-year returns, they are also far more consistently positive.
For someone who invests like Rip Van Winkle, this makes the whole investing thing massively less stressful.
For example, the worst three-year return for the All-Share was for the period ending June 2016. However, the return was still positive, so a passive All-Share investor who slept from June 2013 to June 2016 would have awoken with a portfolio more valuable than the one they fell asleep with, and all of the short-term ups and downs between those two dates would be nothing more than ancient and irrelevant history.
Three years is still probably too short though, and personally, I only look at returns over five years or more. Here’s the five-year total returns chart:
Unlike the roller coaster of one-year returns, five-year returns are almost entirely free of scary volatility.
Admittedly I only have a couple of years of rolling five-year results, so this is quite a limited sample, but the lack of volatility and consistently positive returns are still striking.
I think most investors would be far better off if they could view their investments only through this five-year lens. If they looked at the value of their portfolio today and only compared it to its value five years ago, they’d get a much better picture of how their investments are doing.
Today, for example, my newsletter’s virtual portfolio is worth £99,083. Five years ago to the day, it was worth £59,440. That’s a five-year total return of 67%.
Does it matter that the portfolio was a few percent higher in January than it is today? Of course it doesn’t.
What matters is where the portfolio is today compared to where it was a few years ago, and where it’s likely to be a few years into the future compared to where it is today.
In my opinion, almost everything that happens in the sub-five-year time horizon is noise and should be ignored, perhaps by using the investment equivalent of noise-cancelling headphones.
Higher income? Yes, consistently higher than the market
A portfolio’s yield is either better or worse than the market’s, and that’s about all there is to it, so here’s the relevant chart:
The defensive value portfolio has always had a higher yield than the All-Share, although the winning margin has shrunk recently.
In fact, today the yield on the portfolio and the All-Share are 3.8% and 3.7% respectively, so it will be interesting to see if my high-yield portfolio becomes a low-yield portfolio in the next few months.
If it does then I will try to steer the portfolio towards higher-yield stocks, although not at the expense of the quality or value of future investments.
In other words, if the best combination of growth, quality, income and value just happens to be in lower-yielding stocks at the moment then that’s where I’ll invest. But hopefully, that won’t be the case.
Yield is important, but the total amount paid out each year is also important because that’s what you’ll be living off if you decide to retire on your portfolio’s “natural yield” (although of course there should always be a margin of safety between income required and income generated).
Here then is a chart of total cash dividends paid out each year, all of which are reinvested:
As well as having a higher yield, the defensive value portfolio has paid out a higher dividend in cash terms than the All-Share tracker in every year (except 2011 when the portfolio was slowly being built).
My expectation is that the gap between these two income streams will increase over time and I look forward to the time when my portfolio’s cash dividend exceeds twice that of the All-Share.
Lower risk? Yes, smaller and shorter declines than the market and positive returns over every five year period
Although I repeatedly bang on about the futility of measuring short-term performance and the sanity of focusing on long-term returns, most investors still get upset when their portfolio falls significantly below a previous high, no matter how temporarily.
What is “significant” will vary from person to person, but if the recent market correction and media frenzy is anything to go by, a lot of investors think a 10% decline is significant.
So it seems sensible to try to avoid larger and longer declines if only to avoid a stress-induced heart attack. That’s why one of my risk metrics is the size and duration of declines from previous highs. I think this is more useful than “standard deviation” or “beta“, which most people don’t understand or care about.
Here then is another chart, this time showing declines relative to a previous high:
The All-Share has obviously seen significantly larger declines from previous highs, of around 14% in 2011 and 12% in 2016. The defensive value portfolio’s largest decline so far was about 8%, which isn’t even “correction” territory, so I’m quite happy about that.
In terms of how long these underwater periods have gone on, they’re pretty short given that we’ve been in a bull market (albeit quite a mild one) for most of the last decade.
The defensive value portfolio’s longest period underwater was the eight months between June and December 2014 while the All-Share managed 15 months underwater between July 2011 and October 2012.
15 months doesn’t sound too bad, but remember that the All-Share total return index was underwater for about five years following the dot-com bubble, so we’ll have to wait for a proper bear market before I can say whether my defensive value portfolio really is defensive or not.
Having said all that, I would prefer to focus on five-year returns and not worry about whether my portfolio is down by 10% or whatever over the last year.
So as a long-term investor, my preferred measure of risk is simply this: I don’t want to lose money over any five-year period.
Since I launched the defensive value portfolio in 2011 that goal has easily been exceeded, with total returns over five years almost always being above 60%, but that was in a period of easy gains.
The next major bear market will be the acid test, but until then I will remain fairly confident that this goal of consistently positive five-year returns is achievable.
Low effort? Yes, just a few days each month spent making investment decisions
For most people, the more investment decisions they make the worse their investment results become. That’s why I restrict myself to just one buy or sell decision each month.
My approach is to always make buy or sell decisions during the first week of the month and then I don’t have to keep up with what the market’s doing for the rest of the month (although I do because writing about companies and markets is my job).
This is strategic ignorance in action.
I don’t need to know what my holdings are worth every day, week or month, and watching their values go up and down would either give me a headache or turn me into a day trader. So I ignore them and my sanity and investment performance are better for it.
With one buy or sell decision each month I’ve made three since the last quarterly portfolio update. In summary these were:
This is the slow and steady plod of a long-term investor and it’s unlikely to be material for a new book by Michael Lewis, but it suits me down to the ground and I think a lot of other investors could benefit from walking to this monotonic drumbeat too.
Goals for the next five years
Since I launched the defensive value portfolio in 2011 it has achieved all of its goals, which is nice. In the future, I’d like more of the same. More specifically, I’d like to:
- Beat the market over the next five years
- Have a market-beating dividend yield at all times
- Suffer smaller and shorter drawdowns than the market
- Have a positive five-year return, regardless of what the market does
- Achieve all this while making just one investment decision each month
If you find any of these goals useful then feel free to borrow and tweak them, and if there are any sensible goals you think I’ve missed then let me know in the comments below.