28 September 2021
Rule # 1: Don’t lose money
Warren Buffett has two rules for investment:
Rule # 1: Don’t lose money
Rule # 2: Never forget Rule # 1
I am with him on this one – I hate losing money from investments.
And yet, when I look at my portfolio at the moment, I can see that about 35% of it is losing money or is, at least, most likely to lose money. That’s weird! Why am I investing in all these things that are making me poorer?
The things that I am talking about are the fixed interest and cash parts of the portfolio. Interest rates are now so low that these kinds of investment (pretty much anything that you invest in to earn interest) are losing money after you have accounted for tax and inflation.
Look at it like this: supposing I take a 2-year term deposit with one of the major trading banks.
To see what your real return is, we have to make adjustments for tax and inflation:
Interest rate 1.6%
Less, tax at, say, 25% (0.4%)
Return after tax 1.2%
Less, inflation (3.3%)
Real rate of return -2.1%
And so, to take out such an investment means I lose 2.1% of my spending power each year. In financial jargon (and in reality) I take a real (inflation adjusted) loss.
If 35% of my portfolio is in these sorts of investments (i.e. fixed interest and cash) it is not hard to figure out that the other 65% is in shares and property. This 65% in growth assets (shares and listed property) is, in fact, quite a lot. I have already made a move from income assets (fixed interest and cash) to have a higher percentage in growth assets because interest rates are low. I do not want to move any further in that direction: 65% in growth assets is quite enough for an old(er) chap!
What can I do with my money that means I am not losing out through a fairly big part of the portfolio?
There are a few possibilities:
1. I could cast around looking for fixed interest investment that pay higher interest rate than term deposits. I could probably find investments that would give a better return, but they would almost certainly still show negative real rates of return. In any event, any investment that paid a higher interest rate would come with more risk (possibly a lot more risk – remember the finance company debacle!).
2. I could load up on shares a bit further, but that idea is unattractive. I do not want more volatility in the portfolio; at 65%/35% I already feel a bit stretched.
3. I could look around for an alternative to the income assets: gold, perhaps, or Bitcoin? Well, none of them have any income at all and I am not going to bet my retirement on speculative assets like these.
In fact, there are no other practical options without taking on more risk than I am prepared to take. There are no other suitable assets and, beyond deciding to suffer the additional volatility and investing further in shares and listed property, there are no other alternatives. I do think it reasonable to increase the amount that you have in shares and listed property a little bit, but only a little bit (and I have already done that).
And so, I am going to sit tight and suffer the loses from fixed interest and cash. My attitude is that the fixed interest and cash investments are in the portfolio for a reason: they balance out the portfolio in the sense that they are not as volatile as shares and listed property. Moreover, fixed interest investments rise in value as interest rates fall. While a further fall in interest rates seems unlikely it could conceivably happen.
If there was some major event that drove down the global economy and hit shares and property, interest rates would likely fall further. It is possible that if something major happened now to economic growth, a fixed interest investment at 1.6% could look very attractive (a few years ago a 4% return looked miserly; now investors salivate at the thought).
The fixed interest and cash parts of a portfolio provide a kind of insurance against some negative event; beware of reducing them too far. Even though they are making me a little poorer, I am going to stay with this insurance for the comfort and stability that they give.