Certain Uncertainty - Control what you can Control and Moving into Cash - Part 2 of 5

Tweet

If you have not read Part 1 of this Series, then scroll down the ‘Educational Blogs’ page and it should appear a couple of Blogs before this one. I recommend you read that first.

Moving into Cash
So now that I have ‘set the scene’ with these Concepts of Controllable stuff and Uncontrollable stuff and, likewise, things we can be Certain about and things where we have no Certainty; I want to relate them to the specific Subject of ‘Moving into Cash’ but of course these concepts have wide validity across many aspects of Investing as I pointed out in Part 1.

To be clear on this, I am discussing the subject of whether or not we should sell All or Part of our Portfolios before we foresee a Major Drop in the Markets coming - a bit like we have had this Year with the upcoming Brexit escape from the EU.

I am not really sure how to go about writing this and as much as I know I should plan out a structure, I am not really in the mood for that so I will just crack on with it and of course vigorous use of the ‘Cut ‘N’ Paste’ function should help me sort the resulting mess into something that is almost readable. (Editor’s Note from much later - not doing an Initial Plan was a very big mistake !!)

Moving into Cash - Knowable and Controllable bits
Let’s start off by looking at stuff we can be certain about with regards to the ‘Known Costs’ of Moving into Cash. For the purposes of this bit of spiel, I will assume a Portfolio with 40 Stocks which is similar to my ‘Normal’ Portfolio (the ‘WD40‘) and it will have a mix of Sizes such as a few FTSE100 Jobbies and some FTSE250 and some Smaller stuff - but I won’t do this in specific details - I will ballpark it a bit for efficiency reasons but of course Readers could run the Actual Numbers on a Spreadsheet with how this would relate to their own Portfolio (don‘t be scared by the word ‘Spreadsheet‘ - I did a lot of this in my head and with the use of scrap paper). Let’s also assume that half of the Portfolio is Moved into Cash and that the Cash Position is held for 6 Months - although obviously in reality the time that you are in Cash would differ hugely and the Percentage of your Holdings that are converted into Cash will be varying as the Weeks go by - Moving into Cash is not something I would see as being like an ‘On/Off’ Switch and I would expect it to take place slowly over many Weeks or Months. I have taken a typical Broker Dealing Fee to be a Tenner. 

Note also that I have worked on the basis that all the Stocks/Portfolios are held in a Tax Free Wrapper like an ISA or a SIPP - if you hold the Stocks outside such a Wrapper, then you might incur Capital Gains Tax (CGT) and Dividend Tax and Income Tax depending on your circumstances and Personal Allowances and of course any such Tax Costs could affect your decision about whether moving heavily into Cash is worthwhile or not.

With the above Assumptions in mind, I will now try to outline a Rough Idea of what the Certain Costs of Moving into Cash are likely to be (remember, because these Costs are Certain they are to an extent controllable):

• The Dealing Costs of Selling out and then Buying 20 Stocks (they could be different Stocks or the same Stocks but I will come onto this more as the Blog Series develops) for a typical Broker would be 20 times £10 to Sell and the same to Buy which would total £400.
• Stamp Duty on buying 20 Stocks would vary depending on the size of the Portfolio and AIM Stocks and some others don’t attract Stamp Duty so it is a bit variable. For a Portfolio worth £250,000 the highest likely Stamp Duty total would be £125k times 0.5% if we assume Half of the Portfolio is moved into Cash and all the Stocks bought attract Stamp Duty - this gives a total of £625. Of course in reality these numbers will vary but let’s assume £500 for this exercise.
• Next we have another difficult one to be certain of due to the variables and that is the thorny subject of Dealing Spreads (the difference between the Buy Price and the Sell Price when we Buy or Sell a Share). I have pretty much no idea what this would amount to so I am going to be guessing a lot but I will try and keep it sensible. I have done a few Searches using Google and not come up with anything sensible so in the absence of better Information I will assume that a Blended Rate of 1% to cover the Spread across all 20 Stocks (this would allow for a mix of FTSE100 and Smaller stuff I think but it might be too low) and this would mean an Additional ‘Certain’ Cost of £1250 (1% of the £125k).
• Those listed above are pretty much largely the Knowable Certain Costs but there are a few others that are again very much dependent on Individual Circumstances and some are quite subjective by their nature. These could be things like Capital Gains Tax (CGT) that might need to be paid if the Stocks are held outside of a Tax Wrapper (an ISA or a SIPP etc.), and some Small Costs which might come from paying for Research or something - although I would expect these to be pretty small and many I would see as a Fixed Cost that you pay every year anyway - for example, I pay for SharePad and investors Chronicle every year whether or not I buy or sell any Stocks, so they can be ignored. Another very hidden Cost (in theory you could work out a ‘Cost’ for this - for example by using an Hourly Rate as if you were an Employee dong the ‘work’ of Researching etc. but to most of us this is a Sunk Cost in a similar way to Subscribing to SharePad etc.) arises from doing Research and the time involved and the effort and there is also ‘Opportunity Cost’ where it might be a better and more enjoyable use of your Personal Time to be out playing Golf or down the Pub or something, rather than analysing Company Reports. These kinds of Subjective Costs are ‘Certain’ even if they are extremely difficult to calculate.

So, on this basis, let’s say the Certain Costs of Moving into Cash and then Buying Stocks later is £2150, and the key factor now is how large this is as a Percentage of your Portfolio Value - if you have a big Portfolio then it will be a very small Percentage but that also misses the reality that if you have a Big Portfolio then there could be a lot more Dealing Fees and Spreads and Hassle because you will most likely be unable to Sell big Chunks of Stock or to Buy Big Chunks - unless you are in FTSE100 Stocks. This latter is something often overlooked by People - it astonishes me sometimes that I cannot even get a Quote on a Small Stock for as little as £3000 of Stock on both the Buy and the Sell side - if you focus on Small Stocks and hold perhaps £80k in a Small Stock then you will probably have to Buy and Sell in many smaller Chunks - although a decent Broker would help a lot.

To understand the impact of the £2150 of Costs, this short List should help:

• On a Portfolio worth £50k this is 4.3%
• On a Portfolio worth £75k this is 2.9%
• On a Portfolio worth £100k this is 2.2%
• On a Portfolio worth £125k this is 1.7%
• On a Portfolio worth £150k this is 1.4%
• On a Portfolio worth £175k this is 1.2%
• On a Portfolio worth £200k this is 1.1%
• On a Portfolio worth £225k this is 0.9%
• On a Portfolio worth £250k this is 0.85%
• On a Portfolio worth £300k this is 0.7%
• On a Portfolio worth £350k this is 0.6%
• On a Portfolio worth £400k this is 0.5%
• On a Portfolio worth £500k this is 0.4%
• On a Portfolio worth £750k this is 0.3%
• On a Portfolio worth £1m this is 0.2%

So it is obvious that the bigger your Portfolio the less the Percentage impact although it must be appreciated that the Comments I just made about difficulties of Trading large Stakes must be considered. To add some more context, if you are aiming for 10% Total Return per Year over time (that is my own Personal Target), then for example a £100k Portfolio taking a hit of 2.2% from Certain and Knowable Costs could be seen as quite a significant drag on your aim to reach 10% Return for a given Year.

Rework with 2% Spread
I wrote the previous Text working out the Costs on the basis of 1% as the Spread between the Buy and Sell Prices on a typical Share - but this was merely guesswork. Since writing that I have added a Column onto my SharePad ‘Lists’ Screen and looked at the kind of Spreads that are normal for different Sizes of Shares - e.g. FTSE100, FTSE250, FTSE Smallcaps, AIM etc. Having done this, I actually think that for a Portfolio which has a mixture of Shares like mine does, then 2% would probably be more realistic so I will quickly re-run the Numbers on that basis. I think it depends on the types of Shares you buy - if you tend to go for Smallcaps and AIM Stocks then perhaps even as high as 3% is realistic - I will leave that for you to decide. It is also the case that Spreads (particularly on Smaller Stocks) can vary and when we get in a situation where the Markets are nervous and starting to fall, then the Spreads could easily be wider.

Another 1% on the Spread simply means that the Total Cost Numbers I came up with earlier (£2150), goes up by £1250 which gives a new Total of £3400. I will now rework the Portfolio Size Costs Table with this new number as follows:

To understand the impact of the £3400 of Costs, this short List should help:

• On a Portfolio worth £50k this is 6.8%
• On a Portfolio worth £75k this is 4.5%
• On a Portfolio worth £100k this is 3.4%
• On a Portfolio worth £125k this is 2.7%
• On a Portfolio worth £150k this is 2.3%
• On a Portfolio worth £175k this is 2.0%
• On a Portfolio worth £200k this is 1.7%
• On a Portfolio worth £225k this is 1.5%
• On a Portfolio worth £250k this is 1.4%
• On a Portfolio worth £300k this is 1.1%
• On a Portfolio worth £350k this is 1.0%
• On a Portfolio worth £400k this is 0.9%
• On a Portfolio worth £500k this is 0.7%
• On a Portfolio worth £750k this is 0.5%
• On a Portfolio worth £1m this is 0.3%

Anyway, running the List with 2% Spread has made quite a difference but of course the same principle applies that the Smaller your Portfolio is in terms of Total Value, the larger the % of Costs based on the Assumptions I have used in my simple Model. Note this time that if you have a Portfolio of £100k then 3.4% of your Portfolio will be burnt up by the Costs of ‘Moving into Cash’ - putting this into context, if you are looking for 10% a Year Total Return, then you already have a big drag - in fact, it is probably equivalent to all of your Dividend Payments for 1 year.

Deliberate Errors in my Models
Hey, have you spotted the Deliberate Mistake in my Numbers? If you go back to the Basic Assumptions I made, then I used £500 for the Stamp Duty but that was based on a Portfolio worth £250k just for illustration. Therefore, on bigger Portfolios the Stamp Duty will be higher and for smaller Portfolios it will be less. Again, if you wish to you can rework these Numbers using your own Portfolio Size to get more accuracy for how it would affect you.

In addition, I have included nothing for Dividends that are not received. I won’t go into too much detail here but if you ‘Move into Cash’ for a short period of time (perhaps 6 Weeks or so) to anticipate a Short and Sharp Market Drop, then the Loss of Dividend Payments to your Portfolio might not be material. However, if we took the kind of Examples I was talking about earlier where you move Half of your £250k Portfolio into Cash and do this for 6 months, then if you normally received Dividends equivalent to 3% of your Portfolio over a Year, then moving Half into Cash for 6 Months would cost you 0.75% in Lost Dividends Payments (note - this is not 1.5% which you might at first expect because you have only moved half of your Stocks into Cash). It doesn’t seem much but it is yet another Avoidable Cost if you do not ‘Move into Cash’ and it must be appreciated that in a Real World Example, you would not be able to Buy back your Stocks at exactly 6 Months after Selling them and of course it depends on the timing of Dividend Payments, bearing in mind that Final Dividends tend to be much larger than Interim Payments.

That’s it for Part 2. In the next Part I use the Numbers we have generated above to run some Scenarios for various different degrees of Market Falls to try and illustrate what can happen in practice and to help establish what are the key factors that affect our decision in advance about whether or not we should move all or part of our Portfolios into Cash when we are very confident a Drop is coming. My intention is that Readers will be able to follow the approach used in my Modelling to recreate their own Models that are appropriate to their own Portfolios.

Cheers, WD.