July 7, 2021
The idea of marginal gains has been around for a long time, but it’s probably best known in relation the British cycling team and their preparation for the 2012 Olympics.
Coaches realised that by breaking down everything that goes into the preparation for an event (from bike mechanics to equipment design to athlete health) into the tiniest components, and gaining small incremental advantages in each one, the compounded effect would mean fistfuls of gold medals.
Dust in the team truck was complicating bike maintenance, so the floor was painted white and kept spotless. Riders’ sleep patterns were analysed and optimised, down to their pillow design. Regular hand sanitising was introduced (imagine that!) to reduce the likelihood of minor illnesses interfering with training. Each change on its own seemed small, trivial even, but added together they had a profound effect on results.
The marginal gains (AKA the 1%) principle is not a new one and sport isn’t the only area where it’s been successfully applied. In aviation, psychologists have applied it when making small changes to cockpit design and instrument layout which have made dramatic changes to planes’ safety records.
The idea has also been adopted ad nauseum by every Tom, Dick and Harry with a trendy beard and a wellbeing or fitness blog to peddle (he typed cynically). For obvious reasons, I guess. Fitness and wellbeing are multifaceted things and are clearly about accumulated changes.
But I’ll tell you where it really does apply well - and I’ve got the bullet points to prove it. Financial planning *strokes trendy beard*.
As all my clients will have heard at some point (as I reel off my tedious patter designed to expectation-manage them into submission in preparation for their new life of calculated, numbing predictability with me) good financial planning should be boring.
Your average investor doesn’t need to use edgy, dodgy offshore schemes to have enough money left after tax. They don’t need to chase mind-boggling returns in crypto, or some cult stock on Reddit. They probably don’t even need to chase above-market returns in actively managed funds, where you’re gambling on the extra returns clearing fund costs (and possibly worried about whether the manager’s about to go fully off the reservation, Woodford style).
Truth is, there are plenty of nice, uncontroversial ways to save tax. Plenty of returns in low-cost funds.
Good financial planning is more about adding up the benefits of a host of low-impact improvements over many years, with surprisingly life-changing results. Harnessing the boring to achieve the amazing, to use a line that’s just popped into my head.
Truth is, you probably don’t need those clever tax schemes if you simply make full use of the obvious ones over a nice long holding period.
The tax benefits of ISA allowances don’t seem especially big at first. One year’s allowance (currently £20,000) probably won’t save you much tax on its own, maybe none if income and gains are within your savings and Capital Gains Tax allowances. But if you use the allowance year-in-year-out you can get big amounts into this highly tax-efficient wrapper, with correspondingly big tax benefits. There are lots of ‘ISA millionaires’ out there, with six-figure gains nicely shielded from tax.
Same for pensions. Boring they might be, but allowances (for now) remain generous, and depending on your income and tax status they can get you up-front tax relief as high as 60%. They also remain one of the cleanest and most tax-efficient ways for owner-managers of limited companies to draw profit from their business, in the right circumstances.
This phrase was first coined in 1952 by Harry Markowitz, considered the father of modern portfolio theory. It’s a complex subject involving terms like ‘efficiency frontier’, but the basic point is that when you build an investment portfolio, you can reduce your risk without reducing returns, simply by diversifying the investments held.
It sounds so obvious, you’d think everyone is doing it. But we regularly take over portfolios that have previously been held with ‘traditional’ wealth managers, which are inadequately diversified by asset type, with more volatility than clients are comfortable with, for no measurable performance benefit.
Your nice, diversified, carefully calibrated portfolio won’t stay that way on its own. A portfolio of funds investing in different asset classes will, over time, experience ‘drift’, which is where some asset types grow by more than others, pulling the risk and return profile away from where you want it. Usually, over the long term, riskier assets will go up by more than lower risk assets, creating a less diversified, overall risker portfolio than you started with. Regular ‘rebalancing’ means making a set of buys and sells to bring the portfolio back into alignment. By doing this regularly, volatility is reduced, and returns are smoothed.
This one is subjective, to a degree. Our view is that active management (actively managed funds, or active stock selection, for example by a stockbroker) is generally not cost effective. The chance of beating the market (a possible benefit) is generally not, in our view, high enough to justify the extra costs of attempting to do it (a guaranteed cost).
Some will feel, and it’s a valid approach, that active management at fund level is worth the extra costs. The most important thing is having an approach that feels right for you philosophically, because then you’re more likely to stick to it (see next point). You be you, man!
Advice is, of course, a cost, and for some it’s an unnecessary one *gasp*. I mean that too. If you can do everything in this list confidently, competently, and consistently then you might not need an adviser. Stop reading right now. Sack us.
But a word of caution, weary traveller *raises gnarled finger* - it’s hard to do all these things for yourself. Of course, it takes knowledge, and time, to build and run an investment portfolio and stay on top of tax rules and allowances across tax years. But the hardest thing is behavioural. Sticking to a plan is easier when you have an adviser you trust and work closely with (see next point again).
One of the most fascinating things in my life (and I’m only partially joking) is the ‘Transfer Excess Income / Credits to Savings’ button in our cashflow forecasting software.
If left ticked, this automatically allocates all precited surplus income above spending to a cash account. However, what we found over the years is that this money often, inconveniently, disappears into the ether. It gets spent on mysterious, unidentifiable stuff. Better, we found, to be cautious and leave that box unticked, and not be surprised by a missing million quid at retirement.
But that can be overly pessimistic. Some of the excess probably will get saved or invested, just not all of it. So, we now use positive entries instead of that automatic transfer button. And what we’ve found is that people are much, much more likely to stick to these regular investments if we put them in the forecasts, with specific numbers against them. When things are accounted for in the plan, in specific monetary terms, they are more likely to happen.
The other side of this behavioural advantage is to do with what Carl Richards, in his brilliant 2012 book, calls ‘the behaviour gap’. Individual investors left to their own devices, on average, do dumb things that destroy value. They panic and sell. They get greedy and chase blockbuster returns. It all adds up to a gap between the return that the market produces and what the average investor gets. This is (IMO) the best argument for the cost of advice being a necessary one. It’s easy to stick to a plan for the long term, and avoid potentially catastrophic behavioural faceplants, when you’re collaborating with an adviser you trust. We have the benefit of being a step away from the emotional aspects of your money, like the joyless, dead eyed automata we are. That’s why a surprisingly large number of advisers (in my experience) have advisers themselves. I’ve got one, and we have joyless dead-eyed automata parties.
Anyway, feel free to consider this a wellbeing blog and I’m now off to sanitise my hands, before reapplying white paint to the floor of my dust-free financial planning laboratory.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
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