INB4 predicting the future, but I wanted to ask if you guys think the Vanguard US Equity Index Fund is likely superior to the FTSE Global All Cap Index Fund for a U.K. based investor? I did some analysis below that seems to indicate that this might be the case, based on existing returns, currency risk, and ongoing costs.
My assumptions:
Fund A (Vanguard US Equity Index Fund) average annual return: 15%
Fund B (Vanguard FTSE Global All Cap Index Fund) average annual return: 10%
Fund A expense ratio: 0.1%
Fund B expense ratio: 0.23%
Investment period: 25 years
Initial investment: £10,000
Yearly contribution: £10,000, adjusted for 3% inflation
Salary increase: 3% per year
For both Fund A and Fund B, we will calculate the future value of the investment using the formula for the future value of an increasing annuity:
FV = P * (((1 + r)n - (1 + g)n) / (r - g))
where:
FV is the future value of the investment
P is the initial yearly contribution
r is the net annual return rate (annual return - expense ratio)
n is the number of years
g is the rate of increase in yearly contributions (salary increase - inflation)
Modelling without currency risk, based on historic performance:
For Fund A:
Net annual return after fees = 15% - 0.1% = 14.9% = 0.149 Increase in yearly contributions = 3% - 3% = 0% = 0.0
FV_A = £10,000 * (((1 + 0.149)25 - (1 + 0.0)25) / (0.149 - 0.0))
FV_A ≈ £1,838,336.32
For Fund B:
Net annual return after fees = 10% - 0.23% = 9.77% = 0.0977 Increase in yearly contributions = 3% - 3% = 0% = 0.0
FV_B = £10,000 * (((1 + 0.0977)25 - (1 + 0.0)25) / (0.0977 - 0.0))
FV_B ≈ £899,227.27
The difference in the future value of the investment between Fund A and Fund B is £1,838,336.32 - £899,227.27 = £939,109.05
Modelling with currency risk:
For simplicity, we will assume that the entire return for Fund A (Vanguard US Equity Index Fund) is subject to currency risk, while Fund B (Vanguard FTSE Global All Cap Index Fund) has no currency risk as it is already globally diversified. Although this is a simplification, it will help illustrate the potential impact of currency risk on returns.
Scenario 1: No change in the GBP/USD exchange rate
In this scenario, there is no currency risk, so the future values of Fund A and Fund B remain the same as in the previous example: £1,838,336.32 and £899,227.27, respectively.
Scenario 2: GBP appreciates by 1% per year against the USD
In this scenario, we need to adjust the net annual return for Fund A by subtracting 1% to account for the currency risk: 14.9% - 1% = 13.9% = 0.139
FV_A = £10,000 * (((1 + 0.139)25 - (1 + 0.0)25) / (0.139 - 0.0))
FV_A ≈ £1,549,870.55
Scenario 3: GBP depreciates by 1% per year against the USD
In this scenario, we need to adjust the net annual return for Fund A by adding 1% to account for the currency risk: 14.9% + 1% = 15.9% = 0.159
FV_A = £10,000 * (((1 + 0.159)25 - (1 + 0.0)25) / (0.159 - 0.0))
FV_A ≈ £2,188,817.14
Comparing the future values of Fund A and Fund B under the three currency risk scenarios:
Scenario 1 (No change in GBP/USD):
Fund A: £1,838,336.32
Fund B: £899,227.27
Scenario 2 (GBP appreciates by 1% per year):
Fund A: £1,549,870.55
Fund B: £899,227.27
Scenario 3 (GBP depreciates by 1% per year):
Fund A: £2,188,817.14
Fund B: £899,227.27
Now obviously there are a lot of assumptions going on here such as historic performance and ongoing costs remaining the same into the future, however based on the information at hand, as well as my conviction that the pound will generally strengthen versus the dollar back to where it was but not far beyond, and that the US fund will outpace the Global one, I believe it stands to reason that the US fund is the one where it would be more rational to invest in.
There’s the topic of diversification but both seem very diversified to me.
Is there anything I’m failing to take into account?
Submitted March 25, 2023 at 07:14AM by BastiatLaVista https://ift.tt/UCRxczI
