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Maximum Equity Allocation

Including Financial Independence and Retiring Early (FIRE)
dealtn
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Re: Maximum Equity Allocation

#397627

Postby dealtn » March 21st, 2021, 11:59 am

GeoffF100 wrote:
Real (i.e. after inflation) interest rates on gilts are currently negative. Some index linked gilts have a real redemption yields of less than -3%. They have been as much a +4% in the past. That is not because inflation is expected to be low. It is because the Bank of England has pushed the price up by buying them with printed money. Interest rates could fall without a rise in inflation.


No The Asset Purchase Facility under the auspices of the BoE doesn't buy Index Linked Gilts.

GeoffF100 wrote:
Equities do not entirely protect against inflation. Index linked gilts and other inflation linked bonds do protect against inflation. An index linked annuity is the surest way of protecting your income against inflation.


Inflation linked bonds only provide partial protection against inflation. You would need to take into account the issuer, the purchase price, and your holding period. even an index linked Gilt bought from the Government will only provide inflation linked returns if held to maturity, as it is (extremely likely) to be bought a long way above par. So your "inflation linked bonds" also suffer from the issue of also "not entirely protect(ing) against inflation".

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Re: Maximum Equity Allocation

#397630

Postby tjh290633 » March 21st, 2021, 12:06 pm

GeoffF100 wrote:An index linked annuity is the surest way of protecting your income against inflation.

Time was when you could buy an annuity that was worth having. Nowadays you are merely being paid back the money that you bought it with. By buying an annuity you are giving away any income you might have received from other investments that might have given you an income that could rise faster than inflation.
GeoffF100 wrote: In the UK, the stock market fell by about 75% in the high inflation of the 1970s. After inflation dividends were trashed too. Taxes also rose.

I was there. Here are the records of my relatively small portfolio in that period:

.   Change from Previous Year                    
. Cost @ Value @ Income
. 31 Dec 31 Dec

Dec-71
Dec-72 -7.25% 8.60% -17.07%
Dec-73 7.25% -20.60% 1.17%
Dec-74 -1.06% -36.61% 24.81%
Dec-75 23.15% 118.96% 3.00%
Dec-76 5.72% 3.00% 22.35%
Dec-77 -32.06% -10.48% 16.57%
Dec-78 8.56% 15.72% -24.94%
Dec-79 11.82% 10.45% 27.23%
Dec-80 23.92% 34.35% 27.17%

You may notice the bounce back in value during 1975, and the growth in income. I sold some investments in 1977 to put a deposit down on a new house, under construction. I was otherwise adding to my investments at a modest rate during this period.

TJH

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Re: Maximum Equity Allocation

#397643

Postby GeoffF100 » March 21st, 2021, 12:44 pm

dealtn wrote:
GeoffF100 wrote:Real (i.e. after inflation) interest rates on gilts are currently negative. Some index linked gilts have a real redemption yields of less than -3%. They have been as much a +4% in the past. That is not because inflation is expected to be low. It is because the Bank of England has pushed the price up by buying them with printed money. Interest rates could fall without a rise in inflation.

No The Asset Purchase Facility under the auspices of the BoE doesn't buy Index Linked Gilts.

GeoffF100 wrote:Equities do not entirely protect against inflation. Index linked gilts and other inflation linked bonds do protect against inflation. An index linked annuity is the surest way of protecting your income against inflation.

Inflation linked bonds only provide partial protection against inflation. You would need to take into account the issuer, the purchase price, and your holding period. even an index linked Gilt bought from the Government will only provide inflation linked returns if held to maturity, as it is (extremely likely) to be bought a long way above par. So your "inflation linked bonds" also suffer from the issue of also "not entirely protect(ing) against inflation".

Sorry, I was not clear that "them" was supposed to refer to gilts at the beginning of the paragraph and not index linked gilts at the end. Nonetheless, if the government pushes down the yield on nominal gilts by buying them back, the yield on index linked gilts should fall correspondingly if inflationary expectations remain the same. There are inevitably ifs and buts to that, but I was talking broad brush.

I was thinking about index linked gilts and TIPS, but there are also commercial index linked bonds. (Indeed, I hold some of the Places for People bond.) The capital value and income from IL gilts is index linked, but even if you hold to maturity, there are some ifs and buts. Nonetheless, used appropriately, they are a much safer way of preserving the after inflation value than high yielding shares. At the present time though, that security comes at a great cost. I have hung on to most of mine, but have not bought any more.

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Re: Maximum Equity Allocation

#397644

Postby Wuffle » March 21st, 2021, 12:52 pm

Give or take costs (I know), is an annuity best described as a punt on whether you die when you are supposed to?
Given the binary nature of this should you go half annuity, half investments?
Just askin'.

W.

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Re: Maximum Equity Allocation

#397647

Postby dealtn » March 21st, 2021, 1:12 pm

GeoffF100 wrote: Nonetheless, used appropriately, they are a much safer way of preserving the after inflation value than high yielding shares.


So what is the "appropriate" way to preserve the after inflation value of your investment by buying a bond priced at say 200, that redeems at 100 in real terms?

I would suggest that doesn't preserve it all.

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Re: Maximum Equity Allocation

#397668

Postby Alaric » March 21st, 2021, 3:18 pm

GeoffF100 wrote: In the UK, the stock market fell by about 75% in the high inflation of the 1970s. After inflation dividends were trashed too. Taxes also rose.


There was a theory that in the absence of being able to adjust accounts for inflation, tax was being levied on what was in reality just the paper profits of asset revaluation.

After a low point (as measured by the old FT 30 Index) at the end of December 1974, the market doubled in the next three months. Anecdotal evidence hints that institutional equity fund managers started trading amongst themselves to give prices a kick. But was there also a parallel change to accounting and taxation rules?

But if you substantially held Bonds or cash at the time of decimalisation fifty years ago, the next few years could destroy your wealth.

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Re: Maximum Equity Allocation

#397685

Postby 1nvest » March 21st, 2021, 4:36 pm

GeoffF100 wrote:I am sceptical about gold. It has not been a global currency for a long time, and has little intrinsic value. Warren Buffet is credited with saying that gold is pulled out of one hole in the ground at great cost so that you can pay someone to guard it in another hole in the ground.

As might a farm be bought and left idle. The land value might broadly rise with inflation over time. Work the farm however and it produces dividends. Money was pegged to gold, could be converted at a fixed price, so convert to money and lend that money to the state in return for interest, and later swap back to gold again and the capital+interest bought more ounces of gold than held before. Some countries have much less faith in money that can be deflated away such as printing more to buy up the states bonds to push prices higher/lower interest rates. Or otherwise partially default via one means or another. In India for instance those wishing to hold gold as part of their asset allocation may do so via lending cash in exchange for gold deposited as collateral, typically 75% of spot gold loan value, 0.75%/month, 10%/year loan rate. Whilst on their books that might be counted as gold holdings, when the loan is repaid and the gold returned then they might buy some gold of their own to maintain their overall target gold exposure level. In that context gold earns a 7.5%/year dividend assuming continually rolled. Yet others might borrow gold, as a means to short it (hedge funds/whatever), sell borrowed gold with the intent to buy back and return gold at a later date, in exchange for paying interest on that borrowed gold and where if the short pays off then they pocket the difference.

Most forms of gains, price appreciation, income, volatility capture, can be transposed. Zero coupon bonds swap income over to price appreciation. As can gold-loan type interest be swapped over to volatility capture, where the 'trading method' used can be as simple as periodically realigning (rebalancing) back to target weightings. Selling some ounces of gold to add more stock shares when the Dow/Gold was down at 1 ounce of gold to buy the Dow in 1980, selling some shares to buy more ounces of gold when the Dow/Gold ratio was up at 40 (40 ounces to buy the Dow) and volatility capture gains were massive if timed to perfection, but in practice that timing isn't a reality however partial trading (rebalancing to target weightings) can capture some of those benefits.

50/50 US stock/gold yearly rebalanced since 1972 when the US$ ended its coupling to gold, has yielded near-as the same reward (annualised gain) as 100% stock.

What about art for instance. Keynes' art collection was found (Cambridge university study) to have yielded near the same as stock total returns with dividends reinvested up to 2019, around 6% annualised real. Some 'old money' is content with asset diversification of land, art and gold.

If you don't work money/assets then yes they can equally be fallow. Buy just land and leave it idle for instance might be no different to just buying gold and burying it, or a single piece of art that is never sold, just hung on a wall or rolled up into a tube to be stored in a safe.

I meant interest rates could rise without a rise in inflation, but the converse is also true. The article that I linked is a good one, but US based. In the UK, the stock market fell by about 75% in the high inflation of the 1970s. After inflation dividends were trashed too. Taxes also rose.

Standard practice. Claim a states bonds never default, but that do partially default. Print money to buy bonds and that drives higher prices, lower yields. Control the yield curve to keep yields down at 2%/whatever and the extra money around will likely drive inflation to higher levels than the interest rate ... negative real yields ... a partial 'default'. More so when taxes are also typically increased. But fairly at other times real yields are positive. When positive, cash, bonds, stocks all tend to do well. When negative gold tends to do well. 50/50 cash (deposited earning interest) and gold will tend to have one or the other doing OK no matter if real yields are positive or negative. In effect a barbell. But a better partner to volatile gold prices is volatile stock prices.

What is a good balance? Well you might consider 50/50 stock/gold barbell to be a currency unhedged global bond. 50/50 stock/bonds is widely accepted as being 'neutral' likely to do as equally well across periods of economic expansion and contraction, which if the bonds are a stock/gold barbell = 75/25 stock/gold. That will tend to lag during 'good' times, but decline less during 'bad' times. If stocks (bonds/cash) are all deflated away by negative real yields perhaps seeing half of the inflation adjusted value wiped out then gold will tend to do well, perhaps rising 2.5 times. 75 stock loses half to 37.5, 25 gold rises 2.5 times to 62.5, combined 100 ... no loss, and where that portfolio value is 100% higher than a all-stock portfolio ... in effect having been compensated by a 'insurance' payout (gold) after perhaps many years of paying a premium in the way of lower returns from holding just 75% stock instead of 100% stock. As per 1972 to recent seeing both 75/25 and 100/0 stock/gold having rewarded the same, that all tends to broadly wash, but where the 75/25 tends to have the lower volatility, which equates to a better risk adjusted reward.

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Re: Maximum Equity Allocation

#397688

Postby 1nvest » March 21st, 2021, 5:00 pm

dealtn wrote:
GeoffF100 wrote: Nonetheless, used appropriately, they are a much safer way of preserving the after inflation value than high yielding shares.


So what is the "appropriate" way to preserve the after inflation value of your investment by buying a bond priced at say 200, that redeems at 100 in real terms?

I would suggest that doesn't preserve it all.

Bonds are priced/levelled to what the bond market collectively opines will occur over time. If they are pricing to a 200 down to 100 in real terms decline (deflation) for decades out then they clearly see relatively low/negative returns over those years/decades. Stocks are like a variable coupon undated bond and are not outside of that. Fundamentally the West has a ageing population and where supply using technology/robotics is greater than demand (many having insufficient funds available to buy all of what can be produced). Much of the 1980's/1990's boom for stocks and bonds arises out of very high to very low interest rate transition.

Either there may be decades of low/flat gains, including periods of negative real returns; Or there could be a large hit like in the 1970's that pushes interest rates/inflation to high levels where fast and large losses may be endured by many ... to then start the cycle of subsequent progressive declining yields/interest rates all over again.

Much of the 200 now to buy 100 at a later date of inflation adjusted income/return is a function of prices having been driven to very high levels - good rewards for some, that will likely have to be paid back by others. Bonds provide is a reasonable assured means to secure 100 of inflation adjusted income in x years time, albeit at a 200 or whatever current price. So much does the state see the security of such liability matching that they enforce pension funds to hold such assets, which in turn tends to push prices even higher. If for whatever reason things turned around such that it cost only 50 now to buy 100 of inflation adjusted income in x years time, then bond prices may very well drop 75% relative to current 200 to buy 100 type levels. With other assets such as stocks, you can't liability match 100 of inflation adjusted income/value in x years time. Rather it could be half that, or double ... is more of a bet. And the state would rather pension funds didn't bet, as bad bets would likely have to be bailed out by the state.

Such is the broad inflation adjusted expectancy from bonds (Gilts) the state/treasury don't both with taxing capital gains (price variations), Gilt price gains are exempt from capital gains tax as that's a broadly zero sum game, where collecting taxes would cost time/effort for no overall broad benefit, but yes they do collect taxes on interest payments which is really a form of partial confiscation/default as that is a broad positive sum stance for the treasury.

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Re: Maximum Equity Allocation

#397690

Postby dealtn » March 21st, 2021, 5:07 pm

1nvest wrote:
dealtn wrote:
GeoffF100 wrote: Nonetheless, used appropriately, they are a much safer way of preserving the after inflation value than high yielding shares.


So what is the "appropriate" way to preserve the after inflation value of your investment by buying a bond priced at say 200, that redeems at 100 in real terms?

I would suggest that doesn't preserve it all.

Bonds are priced/levelled to what the bond market collectively opines will occur over time. If they are pricing to a 200 down to 100 in real terms decline (deflation) for decades out then they clearly see relatively low/negative returns over those years/decades. Stocks are like a variable coupon undated bond and are not outside of that. Fundamentally the West has a ageing population and where supply using technology/robotics is greater than demand (many having insufficient funds available to buy all of what can be produced). Much of the 1980's/1990's boom for stocks and bonds arises out of very high to very low interest rate transition.

Either there may be decades of low/flat gains, including periods of negative real returns; Or there could be a large hit like in the 1970's that pushes interest rates/inflation to high levels where fast and large losses may be endured by many ... to then start the cycle of subsequent progressive declining yields/interest rates all over again.

Much of the 200 now to buy 100 at a later date of inflation adjusted income/return is a function of prices having been driven to very high levels - good rewards for some, that will likely have to be paid back by others. Bonds provide is a reasonable assured means to secure 100 of inflation adjusted income in x years time, albeit at a 200 or whatever current price. So much does the state see the security of such liability matching that they enforce pension funds to hold such assets, which in turn tends to push prices even higher. If for whatever reason things turned around such that it cost only 50 now to buy 100 of inflation adjusted income in x years time, then bond prices may very well drop 75% relative to current 200 to buy 100 type levels. With other assets such as stocks, you can't liability match 100 of inflation adjusted income/value in x years time. Rather it could be half that, or double ... is more of a bet. And the state would rather pension funds didn't bet, as bad bets would likely have to be bailed out by the state.

Such is the broad inflation adjusted expectancy from bonds (Gilts) the state/treasury don't both with taxing capital gains (price variations), Gilt price gains are exempt from capital gains tax as that's a broadly zero sum game, where collecting taxes would cost time/effort for no overall broad benefit, but yes they do collect taxes on interest payments which is really a form of partial confiscation/default as that is a broad positive sum stance for the treasury.


Yes. So they don't preserve it at all. It is just "linked".

Buy at 200 and hold to maturity and par real return, you have a loss of purchasing power (but at least know what that lost purchasing power will be). Hold for a period less than until maturity, and you have an unknown real return (which might preserve your purchasing power - or indeed increase it - but less likely the longer you hold it, and the higher the purchase price above par).

So what is this "appropriate" method of using inflation linked bonds to preserve purchasing power that is being claimed?

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Re: Maximum Equity Allocation

#397693

Postby 1nvest » March 21st, 2021, 5:25 pm

tjh290633 wrote:I was there. Here are the records of my relatively small portfolio in that period:

.   Change from Previous Year                    
. Cost @ Value @ Income
. 31 Dec 31 Dec

Dec-71
Dec-72 -7.25% 8.60% -17.07%
Dec-73 7.25% -20.60% 1.17%
Dec-74 -1.06% -36.61% 24.81%
Dec-75 23.15% 118.96% 3.00%
Dec-76 5.72% 3.00% 22.35%
Dec-77 -32.06% -10.48% 16.57%
Dec-78 8.56% 15.72% -24.94%
Dec-79 11.82% 10.45% 27.23%
Dec-80 23.92% 34.35% 27.17%

You may notice the bounce back in value during 1975, and the growth in income. I sold some investments in 1977 to put a deposit down on a new house, under construction. I was otherwise adding to my investments at a modest rate during this period.

Between the start of 1973 and end of 1976 consumer/retail prices had doubled. At the end of 1975 the 118% gain had a prior 50% decline back to break-even in nominal terms, but that was near 50% down in real (after inflation) terms. For your post 1976 figures whilst the gains looked good, inflation still continued along at broadly around 15% levels up to 1980.

Not so bad for a young accumulator, still saving/adding. Not good for someone in retirement/drawdown. Some say that the 60's were even worse however for those in drawdown. The cycle would seem to be bad 1960's/1970's for those in retirement, but pretty good 1980's/1990's. The 2000's seem to be somewhat a repeat of the 1960's, flat/low/negative rewards further eroded by withdrawals. Maybe the 2020's might be a repeat of the 1970's, and the state seems to be gearing towards such ... suppress yields and then if/when inflation spikes occur private wealth is deflated away, potentially massively and over a relatively short timeframe.

Buffett's claim to great gains is largely a function of timeframe. Starting mid 1970's with a 100% single year gain stands well placed to do well subsequently. And with high to low interest rates transition over the following decades having pretty much any asset allocation doing well, cash, bonds, stocks. Buffett had the additional advantages of large amounts of 'free' money. Premiums received in his insurance business in lieu of claims later being paid out and where that 'pool' of money was substantial. Given a 0% cost loan that doubled up the amount of capital you had and even if all was invested in cash (T-Bills) you'd have done well.

As with most things the former generation are leaving the younger generation far worse placed. Less security (pensions/healthcare), a ravage world (pollution), much greater need to self fund education and late life care oneself, and a relatively bleak financial/investment outlook. Not a dig at you personally Terry, rather just a broad observation.

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Re: Maximum Equity Allocation

#397699

Postby 1nvest » March 21st, 2021, 5:40 pm

dealtn wrote:So what is this "appropriate" method of using inflation linked bonds to preserve purchasing power that is being claimed?

Rolling the yield curve perhaps. Buy near the peak of the steepest part of the yield curve and 'trade' rather than holding to maturity. If the yield curve remained unchanged that could yield sufficient gains to offset the negative real yields that otherwise occur if held to maturity. The yield curve however has been artificially flattened, or prior 'insurance' options removed (such as availability of National Savings inflation bonds). Markets aren't free moving anymore, but are propped up by a player with near unlimited capacity to counterfeit more money if/as/when needed. Money backed by nothing tangible has failings, as did money backed by gold (something tangible) also have its failings. When the public sector benefits, golden inflation linked pensions/pay etc. can no longer be paid by the private sector ... troubles. NHS nurses on £35K and good pensions asking private sector care home workers on less than £10/hour to pay more in order to uplift the NHS workers pay ... type situation. Some in the NHS deserve to be rewarded, those who have been on the front lines. In contrast many others don't. Local GP's who had their pay doubled and many who then opted to work part time half weeks, who in many cases haven't been available other than for a telephone chat since Covid.

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Re: Maximum Equity Allocation

#397706

Postby dealtn » March 21st, 2021, 5:52 pm

1nvest wrote:
dealtn wrote:So what is this "appropriate" method of using inflation linked bonds to preserve purchasing power that is being claimed?

Rolling the yield curve perhaps. Buy near the peak of the steepest part of the yield curve and 'trade' rather than holding to maturity. If the yield curve remained unchanged that could yield sufficient gains to offset the negative real yields that otherwise occur if held to maturity.


Such trading wouldn't be riskless, so no guarantee of preservation. Regardless, the shape of the forward real curve, doesn't provide such an opportunity.

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Re: Maximum Equity Allocation

#397746

Postby GeoffF100 » March 21st, 2021, 8:18 pm

dealtn wrote:
GeoffF100 wrote: Nonetheless, used appropriately, they are a much safer way of preserving the after inflation value than high yielding shares.

So what is the "appropriate" way to preserve the after inflation value of your investment by buying a bond priced at say 200, that redeems at 100 in real terms?

I have found an IL gilt that fits that bill quite well:

https://www.fixedincomeinvestor.co.uk/x ... oupid=3530

GBP 19 Mar 2021 TSY 0 3/4% 2047 I/L Gilt GB00B24FFM16 0.75% 22 Nov 2047 26 yrs 8 mths 199.347 -1.989%

The details of the cash flow calculations are here:

https://www.dmo.gov.uk/media/1953/igcalc.pdf

As I understand it, you lose nearly 50% your capital, prior to indexation, over 26 years and 8 months to maturity. You gain about 26.5 years of 0.75% coupons, again prior to indexation. That is a gain of about 22% to offset against the 50% loss. The real redemption yield will depend on the inflation rate assumed, but is shown as -1.989% in the table. Not great, but if you have an index linked liability in 26 years time and do not want to take any risk, you do not have much choice. You ask me for whom such an investment would be "appropriate". I expect that the main buyers would be pension funds and Life Assurance companies. I do not have any specialised knowledge in that field, so I could be wrong.

My IL gilt is:

GBP 19 Mar 2021 TSY 0 1/8% 2029 I/L Gilt GB00B3Y1JG82 0.125% 22 Mar 2029 8 yrs 124.805 -2.637%

I bought them 21/10/14 when the real redemption yield was -0.1%, so they should very nearly keep pace with inflation. They mature when I am 79. There is no CGT to pay and little income tax. They also give me liquidity. They are about 6.5% of my portfolio. Nonetheless, they are worth more than I paid for my detached house 19 years ago, and more than ten years living expenses. They give me some feeling of security. I could sell at a profit, but what would I buy in their place?

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Re: Maximum Equity Allocation

#397794

Postby tjh290633 » March 21st, 2021, 11:08 pm

1nvest wrote:Between the start of 1973 and end of 1976 consumer/retail prices had doubled. At the end of 1975 the 118% gain had a prior 50% decline back to break-even in nominal terms, but that was near 50% down in real (after inflation) terms. For your post 1976 figures whilst the gains looked good, inflation still continued along at broadly around 15% levels up to 1980.

Not so bad for a young accumulator, still saving/adding. Not good for someone in retirement/drawdown. Some say that the 60's were even worse however for those in drawdown. The cycle would seem to be bad 1960's/1970's for those in retirement, but pretty good 1980's/1990's. The 2000's seem to be somewhat a repeat of the 1960's, flat/low/negative rewards further eroded by withdrawals. Maybe the 2020's might be a repeat of the 1970's, and the state seems to be gearing towards such ... suppress yields and then if/when inflation spikes occur private wealth is deflated away, potentially massively and over a relatively short timeframe.

I have just realised that I had more calculations available of IRR from the start to each year end, and also the RPI values based on January 1974=100. That indicates that my rate of return for the 10 years to 1981 was 8.38%, while the RPI grew at an annualised rate of 13.8%, while over the 20 years to 1991, my IRR was 10.89% and the annualised RPI was 9.7%. This is, of course, for a portfolio being built over the 20 year period (and beyond), not for a portfolio purely providing income over the period without addition of capital.

The values of the RPI and the annual inflation rate were:

Date     RPI      Inflation
Dec-71 85.70
Dec-72 93.50 9.10%
Dec-73 100.00 6.95%
Dec-74 119.90 19.90%
Dec-75 147.90 23.35%
Dec-76 172.40 16.57%
Dec-77 189.50 9.92%
Dec-78 207.20 9.34%
Dec-79 245.30 18.39%
Dec-80 277.30 13.05%
Dec-81 313.23 12.96%
Dec-82 325.86 4.03%
Dec-83 342.43 5.08%
Dec-84 359.78 5.07%
Dec-85 379.51 5.48%
Dec-86 394.50 3.95%
Dec-87 407.52 3.30%
Dec-88 468.85 15.05%
Dec-89 512.46 9.30%
Dec-90 535.34 4.46%
Dec-91 549.14 2.58%


TJH

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Re: Maximum Equity Allocation

#397807

Postby JohnW » March 22nd, 2021, 12:15 am

Drag me up to your level of understanding on this, if you can.
GeoffF100 wrote:As I understand it, you lose nearly 50% your capital, prior to indexation, over 26 years and 8 months to maturity.

The current purchase price (which you referenced) was ~£199, redeemed at maturity at £100. I agree with your loss figure, but isn't indexation irrelevant for this part of the overall calculation? Whatever inflation was from issuance to now, and will be from now until maturity, the purchase price is fixed and the redemption price is fixed.
True, the bond will now have an adjusted face value due to the inflation from issuance to now; but that value never seems to be listed anywhere (easy to calculate though - I think) and is omitted in your DMO pdf because their method of coupon calculation adjusts the coupon % rather than the bond face value when calculating coupons. The less logical way to skin that cat, I'd suggest, but I think I can follow it.
GeoffF100 wrote:You gain about 26.5 years of 0.75% coupons, again prior to indexation. That is a gain of about 22% to offset against the 50% loss.

Can you tell me how you got from 26.5x0.75=19, to 22%? Has the calculation taken into account the RPI change since issuance until now?
And lastly, a question more directed at the DMO: why are the yields tabulated as 'real yields' assuming 3% inflation? Yes, we'd like to know the yield the bond is providing when we pay for it above par; and yes, we'd like to know the real yield (not a nominal yield that means little if we don't know what inflation will be); but is a real yield assuming 3% inflation that much use if inflation turns out differently?

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Re: Maximum Equity Allocation

#397810

Postby 1nvest » March 22nd, 2021, 12:37 am

tjh290633 wrote:I have just realised that I had more calculations available of IRR from the start to each year end, and also the RPI values based on January 1974=100. That indicates that my rate of return for the 10 years to 1981 was 8.38%, while the RPI grew at an annualised rate of 13.8%, while over the 20 years to 1991, my IRR was 10.89% and the annualised RPI was 9.7%. This is, of course, for a portfolio being built over the 20 year period (and beyond), not for a portfolio purely providing income over the period without addition of capital.

Thanks Terry.

A 4% SWR (4% of the initial portfolio value drawn as income at the start of the first year, and that amount of income adjusted by inflation as the amount drawn in subsequent years) applied where inflation annualised 13.8% and total returns grew at 8.38% for 10 years would have had just enough capital remaining to provide the income for the 11th year (entire portfolio all spent at the end of the 11th year). That's assuming a linear/constant annualised rate, with a more variable rate that compounded to the 13.8% and 8.38% rates it might have been even worse (sequence of returns risk).

More likely a individual wouldn't have persisted with that. At the end of the 7th year with income (consumer/retail) prices having doubled and their portfolio value having halved in real terms many might opt to pull the plug to 'save what little remained' - which was quite a common choice around that time from my reading of history.

On the flip side, accumulating, it usually works out well to add more into a series of declining prices, that then subsequently 'correct' (soar). Cost averages in at a relatively low valuation levels.

1972 to 1980 inclusive saw a annualised inflation of 14.3% and where gold rose over 4 times in inflation adjusted terms. A 25% allocation would have grown in real terms to more than 100% of the total start date portfolio value. But over other times gold is a drag factor. 1980's and 1990's for instance repeatedly reducing shares/stock to add more ounces of gold only to see gold prices continue to decline. 50/50 stock/gold started in 1980 and ending in 1999 saw something like gold nominal prices having halved, but where yearly rebalancing back to 50/50 would have had you holding 10 times as many ounces of gold.

1980 to 1999 had all-stock annualise around 13% real, 75/25 stock/gold annualised 8.5% real (total accumulation returns after adjusting for inflation). Either was comfortable/very-good. Broadly its better to give up some of the good-times gains and avoid a total loss during bad times, as with a 0.0 valuation at any time it doesn't matter if you make massive gains for a period, it still compounds out overall to zero.

Some say gold is no longer a currency, but in some parts of the world it still is a primary preferred currency. And when the outlook for other assets looks bleak, or negative real returns look/are apparent, then its popularity/price tends to rise substantially. Ditto if there's loss of faith in the domestic currency. Gold was reinstated as a tier 1 currency within the last few years i.e. same standing as a reserve as US$. The US pledged to act responsibility when internationally it was agreed to replace gold with US$, but they abused that position and printed/spent, broke their promises. Accordingly there's a tendency/preference to drift away from the US having dominance as the primary reserve currency. Obviously not good for the US to lose that advantage and they're resisting such at all cost. The IMF would prefer it be the SDR - special drawing rights i.e. a basket of currencies that they define - in effect a currency that the IMF issues, but not a actual currency that people can exchange things for. China would prefer it to be where their currency dominates, or gold. Pretty much China in effect has bought all of the worlds gold and the West largely trades in paper gold, derivatives that if ever called would see vastly more paper gold chasing actual physical gold for delivery. Not even gold funds 'backed by physical gold' should be trusted as push come to shove that gold may be seen to have been 'lent' and not actually available. As such physical gold in ones own hands is more preferred and has a lottery ticket type potential if/when paper gold is challenged for delivery, or can provide portfolio insurance during circumstances such as seen in the 1970's.

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Re: Maximum Equity Allocation

#397826

Postby JohnW » March 22nd, 2021, 8:01 am

JohnW wrote:Drag me up to your level of understanding on this, if you can.
GeoffF100 wrote:As I understand it, you lose nearly 50% your capital, prior to indexation, over 26 years and 8 months to maturity.

The current purchase price (which you referenced) was ~£199, redeemed at maturity at £100. I agree with your loss figure, but isn't indexation irrelevant for this part of the overall calculation? Whatever inflation was from issuance to now, and will be from now until maturity, the purchase price is fixed and the redemption price is fixed.

Clearly, that bolded part was rubbish. Only if there was no inflation between issuance and maturity would your calculation be right. But there has been inflation since issuance; don't we need to include that somewhere to get an idea about yield as it will be at maturity?

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Re: Maximum Equity Allocation

#397830

Postby dealtn » March 22nd, 2021, 8:08 am

GeoffF100 wrote:
dealtn wrote:
GeoffF100 wrote: Nonetheless, used appropriately, they are a much safer way of preserving the after inflation value than high yielding shares.

So what is the "appropriate" way to preserve the after inflation value of your investment by buying a bond priced at say 200, that redeems at 100 in real terms?

I have found an IL gilt that fits that bill quite well:

https://www.fixedincomeinvestor.co.uk/x ... oupid=3530

GBP 19 Mar 2021 TSY 0 3/4% 2047 I/L Gilt GB00B24FFM16 0.75% 22 Nov 2047 26 yrs 8 mths 199.347 -1.989%

The details of the cash flow calculations are here:

https://www.dmo.gov.uk/media/1953/igcalc.pdf

As I understand it, you lose nearly 50% your capital, prior to indexation, over 26 years and 8 months to maturity. You gain about 26.5 years of 0.75% coupons, again prior to indexation. That is a gain of about 22% to offset against the 50% loss. The real redemption yield will depend on the inflation rate assumed, but is shown as -1.989% in the table. Not great, but if you have an index linked liability in 26 years time and do not want to take any risk, you do not have much choice. You ask me for whom such an investment would be "appropriate". I expect that the main buyers would be pension funds and Life Assurance companies. I do not have any specialised knowledge in that field, so I could be wrong.

My IL gilt is:

GBP 19 Mar 2021 TSY 0 1/8% 2029 I/L Gilt GB00B3Y1JG82 0.125% 22 Mar 2029 8 yrs 124.805 -2.637%

I bought them 21/10/14 when the real redemption yield was -0.1%, so they should very nearly keep pace with inflation. They mature when I am 79. There is no CGT to pay and little income tax. They also give me liquidity. They are about 6.5% of my portfolio. Nonetheless, they are worth more than I paid for my detached house 19 years ago, and more than ten years living expenses. They give me some feeling of security. I could sell at a profit, but what would I buy in their place?


It doesn't fit the bill quite well at all.

You made a claim index linked bonds would preserve (real) capital, or purchasing power. This bond doesn't, (by your own admission), nor do any others currently, at least if held to maturity, and have no guarantees of doing so if held for a shorter maturity.

I didn't ask you for whom such an investment would be appropriate. I can work that out for myself. As I postulated, such bonds, if held until maturity, suit the person, or institution, that requires a known loss of purchasing power, valuing that more than an unknown one.

You made the claim
GeoffF100 wrote:Equities do not entirely protect against inflation. Index linked gilts and other inflation linked bonds do protect against inflation.


and then
GeoffF100 wrote:Nonetheless, used appropriately, they are a much safer way of preserving the after inflation value than high yielding shares.


I asked you to describe this "appropriate" method of using inflation linked bonds, that have this "much safer way of preserving" property.

I can't see a way of "preserving" purchasing power at all. The best is knowing how much real capital, and purchasing power you will lose.

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Re: Maximum Equity Allocation

#397833

Postby GeoffF100 » March 22nd, 2021, 8:30 am

JohnW wrote:The current purchase price (which you referenced) was ~£199, redeemed at maturity at £100.

No. At maturity, the payout = £100 x index_ratio. The index_ratio is the price index that applies at maturity, divided by the price index that applies at purchase. Multiplying by the index ratio is called indexation. In the case of the IL gilt that I hold, the index is RPI, but the index has been changed for this longer dated IL gilt. The dates for indexation lag the purchase and maturity dates.

JohnW wrote:Can you tell me how you got from 26.5x0.75=19, to 22%?

The interest is compounded (assuming that you reinvest the coupons): 1.0075^26.5 = 1.21897. The payout is roughly 0.5 * 1.22 * index_ratio = 0.61 * index_ratio

JohnW wrote:And lastly, a question more directed at the DMO: why are the yields tabulated as 'real yields' assuming 3% inflation?

The inflation rate at which conventional and index linked gilts give the same return has usually been about 3% in recent years. If you want to know the real redemption yield for other inflation rates, you can work it out for yourself.


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