Austerity in UK - Do I try timing the market?

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Austerity in UK - Do I try timing the market?

Postby LondonJimmy » Wed May 08, 2013 4:47 am

So there is a great debate whether we need stimulus of austerity in our current climate. I am generally of the view that we need stimulus now and worry about making cuts when employment picks up. We have seen European countries facing massive trouble with austerity and the economy getting worse.

I live in the UK and the government seems adamant on getting the debt down. This leads to unemployment and resources not being used. This could depress the economy. If we take away stimulus stock prices will fall. They are already high in nominal terms.

This leads me to my question. I am 28 years old and have a fairly large amount to invest. I want a low cost index-fund like from Vanguard and I will follow the three-find portfolio.

1) Since this will be from a long-term point of view, do I simply invest now and not worry about where the market it going in the future?

2) Do I pay any attention at all to monetary policy?

3) If indexing, do I look at world stocks for exposure, or would I be better off tracking the S&P or FTSE? I live in London so maybe having some exposure to the US would be good for diversification? If so, what is the cheapest way to do this as surely I would have to pay fees when investing abroad from the UK?

Thanks.
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Re: Austerity in UK - Do I try timing the market?

Postby Carpe » Wed May 08, 2013 6:14 am

LondonJimmy wrote:So there is a great debate whether we need stimulus of austerity in our current climate. I am generally of the view that we need stimulus now and worry about making cuts when employment picks up. We have seen European countries facing massive trouble with austerity and the economy getting worse.

I live in the UK and the government seems adamant on getting the debt down. This leads to unemployment and resources not being used. This could depress the economy. If we take away stimulus stock prices will fall. They are already high in nominal terms.

This leads me to my question. I am 28 years old and have a fairly large amount to invest. I want a low cost index-fund like from Vanguard and I will follow the three-find portfolio.

1) Since this will be from a long-term point of view, do I simply invest now and not worry about where the market it going in the future?

In principle, yes. However, some work is necessary before you "jump in". The jumping in bit is really the last piece of the puzzle - executing your plan if you like. What you need is a plan. This involves determing what assets you want to invest in, how you will manage them (e.g. re-balancing), and how the asset allocations will change with time. An ideal situation would be that your asset allocation you are comfortable utilizing now.
2) Do I pay any attention at all to monetary policy?

Not really the Boglehead way of doing things. You would be better off paying attention to your own human capital. This, by far, will outperform anything you might typically expect to get back from any other form of investment. For your investments, get a sensible plan together, ideally boring with not too much or too little risk, and get it on autopilot (allowing your fixed income / equity ratio to follow a glide path as you get older) so that you can get on with your life.
3) If indexing, do I look at world stocks for exposure, or would I be better off tracking the S&P or FTSE? I live in London so maybe having some exposure to the US would be good for diversification? If so, what is the cheapest way to do this as surely I would have to pay fees when investing abroad from the UK?

Thanks.

For a UK investor, you should certainly be looking at a split between "domestic" and "international" stocks, but there is no need to single out "US" unless you want to pursue sector based investing.

Using Vanguard as an example (https://www.vanguard.co.uk/uk/mvc/investments/mutualfunds#mf_fundstab), there a combination of "FTSE Developed World ex-U.K. Equity Index Fund" and "Emerging Markets Stock Index Fund " would provide a simple means of internataional exposure.

For UK domestic I use the Vanguard FTSE All-Share - There is no Vanguard UK equivalent to the Total Stock Market Index Fund. You might have access to something that offers more diversity.

I don't have the time at the moment to comment on the Fixed Income side - perhaps someone else will chime in - although I would caution you to beware of the larger duations that exist for Vanguard FI funds.

You might also care to look at the wiki for UK investors:

http://www.bogleheads.org/wiki/UK_Investing
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Re: Austerity in UK - Do I try timing the market?

Postby wriggly » Wed May 08, 2013 7:31 am

LondonJimmy wrote:So there is a great debate whether we need stimulus of austerity in our current climate. I am generally of the view...


Possibly one of the hardest paths on the road to Boglehead enlightenment is to recognise that your views, whether they be the result of hours of intellectual investigation or simply gut instinct, have no bearing on what will actually happen.

There are cases where stimulus has indeed pulled a country out of the economic doldrums, but there are also cases where widely despised austerity measures proved in the end to be the right path. Australia's relatively smooth economic path through the current crisis is partly due to an unpopular drive to move from budget deficits to budget surpluses in the late 90's and early noughties.

So, the answer is, no, don't try timing the market based on your perceptions of austerity vs stimulus. And yes, diversify your stock investments outside the UK, not just to the US, but to the whole world.

For achieving the effect of a 3-fund portfolio in the UK, you might consider:

- a 1-fund portfolio from the Vanguard LifeStrategy fund range

- a 3-ETF portfolio - Vanguard All-World ETF (developed), Emerging Markets ETF, and UK Govt Bond ETF

- a 4-fund portfolio - Vanguard UK Equity, Developed World ex-UK, Emerging Markets, and either Global Bond (shorter duration, 0.25% TER) or UK Government Bond (longer duration, 0.15% TER).

You can also look at index funds from HSBC and ETFs from BlackRock and iShares.
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Re: Austerity in UK - Do I try timing the market?

Postby larryswedroe » Wed May 08, 2013 7:44 am

Few thoughts
Swedroe rule one, whatever you know the market surely knows and has already incorporated into prices, making it too late to act.
On austerity, without getting into argument about it, there is no science to prove austerity lowers economic growth, in fact there are arguments that it helps, certainly over long term which markets look at. And you can offset fiscal austerity with monetary ease. The failure to do this type of stage two thinking leads to investors making mistakes.
And of course you should be globally diversified with only a relatively small allocation to the UK, given its relatively small share of the global markets (don't make the mistake of home country bias).

I hope that is helpful
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Re: Austerity in UK - Do I try timing the market?

Postby LondonJimmy » Wed May 08, 2013 8:08 am

Thanks for all the excellent replies everyone. I will look into exactly what is said and also post what I do. I really like the advice that you have given to me.

Just to discuss the austerity (which I would usually be for) I believe all the cases where it works is with either a) we have had much higher interest rates and could have brought them down, and b) where there was a major currency devaluation which helped exports. However, we can't devalue our currency due to there being no currency to devalue against. Thus we have everyone, the private sector and government, slashing at the same time which leads to no competition for resources and a depression.
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Re: Austerity in UK - Do I try timing the market?

Postby Carpe » Wed May 08, 2013 8:46 am

wriggly wrote:
- a 4-fund portfolio - Vanguard UK Equity, Developed World ex-UK, Emerging Markets, and either Global Bond (shorter duration, 0.25% TER) or UK Government Bond (longer duration, 0.15% TER).



A recent suggestion has also been iShares II Plc FTSE Gilts UK 0-5 (IGLS). This could be used in conjunction with the UK Government Bond fund (average duration 9.4 years as of March 31st, 2013) for a combined lower duration, say 5 years, whilst maintaining all your Fixed Income as "Treasury Grade".
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Re: Austerity in UK - Do I try timing the market?

Postby magneto » Wed May 08, 2013 9:33 am

If the object is to have only a few funds then agree with Larry Swedroe stock emphasis should be world funds (VWRL or IWRD), as UK represents only about 8% of world market cap.

Rick Ferri in his book AAAA suggests that all investments should provide a real return above inflation. That presents a problem for fixed income. Conventional gilts don't pass the hurdle and Index Linked Gilts (INXG) are pricey. This led me to look at the Infrastructure fund HICL as an alternative not entirely satisfactory diversifier with a positive real yield. It does perform somewhat like a bond, although strictly a stock. That leaves the last option as cash which does not provide a real return above inflation but at least is nominally safe in a period of high bond/gilt prices while we wait for better days.

My personal preference is to DCA (£CA) towards the ultimate Asset Allocation in small increments over three to four years. This may or may not be the lowest book cost option but should keep one on an even balance psychologically through market turmoils.


Good Luck
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Re: Austerity in UK - Do I try timing the market?

Postby Clive » Wed May 08, 2013 9:54 am

Around 70% of the FT100 profits are derived from overseas earnings. The FT100 represents around 80% of the total UK market capitalisation.

Gilts (treasury bonds) with 5 years remaining to maturity can be bought and held in an ISA (tax exempt). When each rung of a 5 year ladder is held to maturity there's no capital risk, and maturing rungs roll into higher or lower yields according to whether yields rise or fall.

Consider a 50-50 of the two, each year you have 20% of the gilts maturing (10% of total portfolio amount). If stocks had declined 40% (pretty extreme historically), then the maturing gilt rung would simply roll into buying more stock that year (leaving an empty rung, that might be filled at other times when stocks were doing well). i.e. review and rebalance as-and-when a gilt has matured.

Whilst many seem to advocate lumping in as soon as funds are available, if your investment horizon is say 30 years then that could hit the worst possible case. Cost averaging in over several years reduces the risk of having invested 100% into that worst case (imagine perhaps 3 x 30 year rungs rather than a single rung, the average of the 3 rungs will be better than the worst case). For funds 'waiting to be invested', choose a stable value asset allocation - perhaps something like 15% in each of an energy fund (or oil stocks), smaller cap (FT250) and gold, and the remainder in gilts that mature in alignment when the next 'investment' amount will be made (1, 2, 3 year gilt ladder (or more if you opt to cost average in over a longer period of time)). That will bear some volatility risk, but along the lines of the likes of PRPFX volatility/rewards, for example using US data that compares non rebalanced 15% IYE, 15% GLD, 15% VBR, 55% TIP total gains to that of 100% PRPFX :

Image

but that will keep the difference from having 'delayed' investing more acceptable (cost of delay = spread between the target investment gain minus the stable value gain - which could be a profit rather than a deficit if the target investment had gained less (lost more) than the stable value asset allocation).
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Re: Austerity in UK - Do I try timing the market?

Postby LondonJimmy » Wed May 08, 2013 10:24 am

Sorry to ask a silly question, but wouldn't it be a two fun portfolio if I invest in VWRL and say, VBMFX?

Would anyone recommend investing another fund for stocks? VWRL looks to have it pretty covered. I just saw in another thread something about total stock market, total international, and total bond market.

Thanks again.
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Re: Austerity in UK - Do I try timing the market?

Postby wriggly » Wed May 08, 2013 11:53 am

The majority of advice on this forum is relevant to investors located in the US. In the UK, you need to adjust the recommendations slightly.

The goal of the 3-fund portfolio is to provide a simple portfolio diversifying over all the stocks in the world, alongside good quality domestic bonds to reduce volatility. The fact that it involves 3 funds is merely a side-effect of an often preferred way to do this in the US. It is possible, for instance, to achieve the above goal (in the US) using just two funds.

In the UK, it is almost always better to use European funds rather than US funds to build a portfolio, primarily because investing in US funds typically involves extra costs, and also triggers complex tax concerns.

The key is that you are not aiming to match the exact number of funds. You are aiming to use a small number of funds to get a portfolio diversifying over all the stocks in the world, alongside good quality domestic (UK) bonds.

Due to the more limited choices in the UK, this may mean using more than 3 funds to get equivalent diversity.

VWRL provides access to all stocks in developed countries, but no access to stocks in emerging countries. It is not necessary to invest in emerging countries, so yes, a two-fund solution would be OK, or a 3-fund solution adding Emerging Markets. However, make sure you know the difference between a mutual fund and an ETF before investing, particularly with respect to trading costs, spreads, and dividend reinvestment.
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Re: Austerity in UK - Do I try timing the market?

Postby MnD » Wed May 08, 2013 12:37 pm

My allocation on the equity side approximates Vanguard Total World Stock so I really don't worry about these kind of questions.
Maybe my home country will be a winner or a loser but I'll just keep buying the planet and get the average.
My home value and my human capital has plenty of implicit home country bias - I don't need any more of it in my investments.
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Re: Austerity in UK - Do I try timing the market?

Postby xxd091 » Thu May 09, 2013 3:36 am

Just my twopennys worth-As Vanguard Funds became available at long last in UK-I moved my Portfolio from Investment Trusts-many of which were closet World Index Trackers anyway- to equivalent cheaper Vanguard Funds-VVDVWE and VVUKEQ. Am now in the process of converting a short term-5years- Gilt ladder to VIGBBD. All in pursuit of simplicity,cheapness,hopefully better performance and the 3 Fund portfolio.So far all appears to be going well.Wonderful to be able to "Boglehead in Britain" at last! I am now off to fish!
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Re: Austerity in UK - Do I try timing the market?

Postby Valuethinker » Thu May 09, 2013 7:45 am

LondonJimmy wrote:So there is a great debate whether we need stimulus of austerity in our current climate. I am generally of the view that we need stimulus now and worry about making cuts when employment picks up. We have seen European countries facing massive trouble with austerity and the economy getting worse.

I live in the UK and the government seems adamant on getting the debt down. This leads to unemployment and resources not being used. This could depress the economy. If we take away stimulus stock prices will fall. They are already high in nominal terms.

This leads me to my question. I am 28 years old and have a fairly large amount to invest. I want a low cost index-fund like from Vanguard and I will follow the three-find portfolio.

1) Since this will be from a long-term point of view, do I simply invest now and not worry about where the market it going in the future?


Yes.

2) Do I pay any attention at all to monetary policy?


Only in this way. It's more likely that sterling will be weaker, than stronger. (but of course it depends entirely on what other Central Banks do, as well).

[/quote]
3) If indexing, do I look at world stocks for exposure, or would I be better off tracking the S&P or FTSE? I live in London so maybe having some exposure to the US would be good for diversification? If so, what is the cheapest way to do this as surely I would have to pay fees when investing abroad from the UK?

Thanks.[/quote]

I would globally index by global weightings to the greatest extent possible. Good news with the FTSE is that many of the companies, including all the largest ones, are international companies so you are getting diversification that way.

On bonds, I would tend to hold sterling bonds primarily-- gilts and index linked gilts. No real point taking currency risk when there is no evidence that it will be rewarded.
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Re: Austerity in UK - Do I try timing the market?

Postby LondonJimmy » Thu May 09, 2013 8:14 am

Thanks for all of the replies.

I am thinking something along the lines of 10-20 % in U.K. Government Bond ETF - VGOV, 20-30% FTSE Emerging Markets ETF - VFEM and 60% in FTSE All-World ETF - VWRL.

I am not really sure why people hold an Index mutual fund instead of an Exchange-traded fund. I thought the fees for an ETF were lower.
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Re: Austerity in UK - Do I try timing the market?

Postby Valuethinker » Thu May 09, 2013 10:26 am

LondonJimmy wrote:Thanks for all of the replies.

I am thinking something along the lines of 10-20 % in U.K. Government Bond ETF - VGOV, 20-30% FTSE Emerging Markets ETF - VFEM and 60% in FTSE All-World ETF - VWRL.

I am not really sure why people hold an Index mutual fund instead of an Exchange-traded fund. I thought the fees for an ETF were lower.


Way overweight in Emerging Markets-- I'd be closer to 10% personally. (if EM are 20% of developed markets, then that would be 20% of 60% is 12%). Emerging Markets are volatile and it's not proven that they pay higher returns to shareholders, commensurate with risk. Go look at what EM did in 1994, or 1997-98. Imagine losing 60%+ of your portfolio value.

With 90% in equities, you could easily lose 45% of your money in a short space of time. Happy to enjoy that level of risk?

I would be more like 30% in bonds: 10% index linked gilts, 20% UK government bonds. 10% EM. 60% global equities (including the UK).
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Re: Austerity in UK - Do I try timing the market?

Postby LondonJimmy » Thu May 09, 2013 10:35 am

Valuethinker wrote:With 90% in equities, you could easily lose 45% of your money in a short space of time. Happy to enjoy that level of risk?



I have a very very strong stomach for risk. This is one of the things that attracted me to this forum - if I follow the advice I will control myself. I recently had 50% of my net worth (which is a large amount) in gold and silver LOL!.

Anyway, losing 45% wouldn't make me happy, but I wouldn't be that bothered as it would be in an index - so over time I would feel very confident of making it back since I am just holding it. As I get older I would accumulate more and more bonds.

Thanks for making the interesting point about not being sure if EM pays for the extra risk. I will think about it.

I think I have to run over numbers and really go through it to see what sort of risk I should take fot what sort of reward. Although history doesn't tell us the future, I should run throught what sorts of portfolios have been producing what sorts of ROI's.
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Re: Austerity in UK - Do I try timing the market?

Postby Valuethinker » Thu May 09, 2013 10:53 am

LondonJimmy wrote:
Valuethinker wrote:With 90% in equities, you could easily lose 45% of your money in a short space of time. Happy to enjoy that level of risk?



I have a very very strong stomach for risk. This is one of the things that attracted me to this forum - if I follow the advice I will control myself. I recently had 50% of my net worth (which is a large amount) in gold and silver LOL!.


That is not risk appetite so much as risk perverse. High risk without the prospect of high returns. You might as well open up an account at IG Index and start spread betting.

Anyway, losing 45% wouldn't make me happy
, but I wouldn't be that bothered as it would be in an index - so over time I would feel very confident of making it back since I am just holding it.


Not a sure thing, alas, in any single lifetime.

As I get older I would accumulate more and more bonds.


Bonds lock in your nominal return, but not your real return. Only inflation linked bonds do that (and then there is tax).

Thanks for making the interesting point about not being sure if EM pays for the extra risk. I will think about it.

I think I have to run over numbers and really go through it to see what sort of risk I should take fot what sort of reward. Although history doesn't tell us the future, I should run throught what sorts of portfolios have been producing what sorts of ROI's.


On EM Returns read Dimson and Marsh 'Triumph of the Optimists'. It is not the high GDP growth economies which have the best stock market performance.

On returns generally, you should read Ilamen 'Expected Returns' is, I think, the title of his book (eye-el are the first two letters of that name). Published by John Wiley.

Returns are kind of given. Long run, stocks will do 3% real above bonds. Maybe 4% pa with a fair wind. You just have to live long enough. Focus on the downside-- know how bad things really got.

Just to provide a degree of immunity to risk perversion, you should definitely read some books of stock market history:

- The Great Crash by John Kenneth Galbraith
- Manias, Panics and Crashes by Charles Kindleberger
- Liar's Poker by Michael Lewis, also The Big Short

I am not sure what the definitive book of the 1966-1980 period is but Maggie Mahar's 'Bull' is a good place to start on 1980-2000. Adam Smith's 'The Money Game' is a classic of the 1970s.

Burton Malkiel's 'A Random Walk Down Wall Street' used to have a fair bit of stock market history in it. Robert Shiller's Irrational Exuberance (both editions) and his website.

You really need a history of the UK stock market in the 1970s.

Understand this. In the 1972-74 period the UK market dropped over 80% in real terms. Imagine losing 80%+ of your wealth.
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Re: Austerity in UK - Do I try timing the market?

Postby Valuethinker » Fri May 10, 2013 2:39 am

MnD wrote:My allocation on the equity side approximates Vanguard Total World Stock so I really don't worry about these kind of questions.
Maybe my home country will be a winner or a loser but I'll just keep buying the planet and get the average.
My home value and my human capital has plenty of implicit home country bias - I don't need any more of it in my investments.


A slight caveat.

A UK person has future liabilities in *pounds sterling*. Whilst we have a large percentage of imports into the country (largest trade partner is the Eurozone) and particular sensitivity to the USD (especially petrol prices) it's still the case that more than 50% of your future spending (think: housing, healthcare, tuition fees, retail markup on goods and services, just about any service you buy) is in GBP.

So it does matter to you what the pound does, long run.

The solution is to hold safe assets (ie the ones that match short and medium term cash liabilities) in GBP: ie gilts (UK government bonds for the casual reader).

Equity assets I agree with a strategy of global diversification. The gains are relatively small, but the smaller your domestic stock market, the greater they are. ie an American could safely ignore international equity markets (but shouldn't) but a UKian ignores them at his/ her peril. Particularly given the sector biases of the UK stock market (heavy towards banks & natural resources, very little technology or industrial).
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Re: Austerity in UK - Do I try timing the market?

Postby wriggly » Fri May 10, 2013 7:41 am

LondonJimmy wrote:I am not really sure why people hold an Index mutual fund instead of an Exchange-traded fund. I thought the fees for an ETF were lower.


If only it were that simple.

As well as the TER/OGC which you are comparing, there is also the purchase and redemption costs. Funds generally are up-front about these - it is trivial to see these extra charges on the Vanguard UK site. For ETFs there are no explicit charges, but there is a "spread", a difference between the buying and selling price. It's not possible for an ETF to publish these, as they are not static. But basically, if you buy an ETF today, and sell it tomorrow, and the market does not move in the meantime, you should expect to end up with less money.

If a Vanguard fund charges a purchase or redemption fee, it is based on real costs involved in buying or selling the underlying assets. (This is not always true for other fund families - funds often have 2-5% up-front fees for the sole reason that the fund company wants more profit). An ETF investing in the same assets will also face these costs, and you would expect the ETF's spread to be larger to reflect these costs.

In addition to this, in the UK, Vanguard has £100,000 minimum for each fund to invest directly with them. If you want to hold less than that, or if you want to use tax wrappers such as an ISA, you will also need to pay a "platform" for access. Each platform has additional fees, and you need to explore which is best for your circumstances. Typically, you may find some combination of annual fee, per-fund fee and transaction fee. And these fees may be different for funds or ETFs. So, if you want to make monthly contributions, you may want to pay a higher annual fee with lower transaction fees. If you want to make one top-up per year, you may prefer a higher transaction fee but a lower annual fee.

Finally, UK funds typically have two types of units, accumulation and distribution. Accumulation units re-invest any dividends back into the fund. Distribution funds and ETFs pay the dividends out. Hence, if you invest in ETFs and you want to re-invest dividends, you will pay more transaction charges to your platform, an additional cost.
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Re: Austerity in UK - Do I try timing the market?

Postby LondonJimmy » Fri May 10, 2013 9:08 am

wriggly wrote:VWRL provides access to all stocks in developed countries, but no access to stocks in emerging countries.



Is this true?

From Vanguard:

"This Fund seeks to provide long-term growth of capital by tracking the
performance of the Index, a market-capitalisation weighted index of
common stocks of large and mid cap companies in developed and
emerging countries
"

So would investing in emerging markets seperately still make sense?
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Re: Austerity in UK - Do I try timing the market?

Postby LadyGeek » Fri May 10, 2013 9:25 am

The wiki might be able to shed some light: UK Investing Take a look at the suggested funds.

The section under Implementation discusses the size of the UK market vs. global allocations.
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Re: Austerity in UK - Do I try timing the market?

Postby LondonJimmy » Fri May 10, 2013 9:45 am

Thanks a lot LadyGeek.

I will have a proper study.
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Re: Austerity in UK - Do I try timing the market?

Postby wriggly » Fri May 10, 2013 11:17 am

LondonJimmy wrote:
wriggly wrote:VWRL provides access to all stocks in developed countries, but no access to stocks in emerging countries.



Is this true?

From Vanguard:

"This Fund seeks to provide long-term growth of capital by tracking the
performance of the Index, a market-capitalisation weighted index of
common stocks of large and mid cap companies in developed and
emerging countries
"

So would investing in emerging markets seperately still make sense?


You should believe Vanguard over me. I invest using their mutual funds, and have only briefly looked at the ETFs.

If you choose to use ETFs, it would be quite reasonable to invest the entire equity part of your investment in this ETF.
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