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A ‘Set-and-Forget’ Investment Approach? Forget it!

Systematic, evidence-based investing often results in very little activity in a portfolio.  It is wrong to think that this is the result of a ‘set-and-forget’ strategy.  The Firm’s Investment Committee would be aggrieved at such a suggestion!  Considerable effort goes on behind the scenes to allow this state of calm consistency to exist.  The fortitude and discipline to deliver ‘not much needs to be done to your portfolio except for rebalancing’ advice, comes from a rigorous process of ongoing challenge to the status quo.  

The broad terms of reference of the Investment Committee are set out below:

 

Manage risks over time

  • The Investment Committee is responsible for the oversight of the risk in portfolios and the wider investment process.  Meetings are regular and minutes are taken, which include all action points to be followed up on. Third-party inputs and guest members – such as Albion – provide independent insight and challenge.

  Challenge the process

  • The investment process at the Firm is driven by the latest empirical evidence and theory available. It is always open to challenge. If new evidence suggests that doing things differently would be in our clients’ best interests, then we will revise our approach. The investment process is evolutionary, but change is most likely to be slow and incremental.

Review the portfolio structure

  • The underlying characteristics of the Firm’s client portfolios are reviewed, including performance and risk level attributes. Risks (asset class exposures) and their allocations within a portfolio are evaluated. Any issues are raised and resolved. Existing asset classes are reviewed alongside asset classes and risk factors that currently sit outside the portfolios.  Areas of interest are placed on a longer-term ‘watch’ list.

Review the incumbent ‘best-in-class’ investment products

  • The incumbent products are ‘best-in-class’ choices seeking to deliver the returns due to investors for taking specific market risks. Each product has a role to play in a portfolio and its ability to deliver against this objective is regularly reviewed. Any product-related issues are raised and resolved.

Screen for new products and undertake appropriate due diligence

  • Although the incumbent products were recommended as ‘best-in-class’, new products are regularly being launched. Tough screening criteria are in place against which new funds are judged. New, potential ‘best-in-class’ products face detailed due diligence and approval.  They are included only when they make the grade. Given the quality of the products already in portfolios, the threshold for replacement is high, but not insurmountable for newer products.

Reaffirm or revise the investment process 

  • The Investment Committee is accountable for reaffirming or revising the structure of client portfolios. Risk (asset) allocations and product changes are approved by the Investment Committee.  Any actions arising from portfolio revisions will be undertaken, after discussion with and agreement by clients.

The next time you open your latest valuation report, remember that despite the lack of activity on the surface, the Investment Committee continues to paddle furiously behind the scenes to allow this be the case.  In the immortal words of the investment legend and author Charles Ellis:

‘In investing, activity is almost always in surplus.’

Perhaps we should amend this slightly to:

‘In investing, activity is – except for the Investment Committee –almost always in surplus.’

Other notes and risk warnings

This article is distributed for educational purposes only and must not be considered to be investment advice or an offer of any security for sale. The reference to any products is made only to make educational points and must, in no circumstances, be deemed to be any form of product recommendation.

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. 

It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

Rebalancing – Do I Really Have to?

Humans have a hard time being investors.  Normally, we like to purchase things when they are cheap and avoid them when they are expensive, but that is often not the case for equities.  We tend to get overly optimistic and enthusiastic when equity markets rise dramatically, as they have done since the Global Financial Crisis a decade ago.  Yet when markets fall materially, we feel bruised and cautious, seeking to hang onto our stable bonds and even selling equities to avoid further falls in portfolio value.  That’s rarely a good idea, especially if you do not need the bulk of your capital in the foreseeable future.

As a client you will know that we have always sought to rebalance your portfolio on a regular basis, by which we mean returning it to the original target allocation that we initially established with you.  Most often, over the past few years, rebalancing has meant selling growth assets (equity-like) and buying defensive assets (bonds) in a contrarian manner.  This has helped to avoid the portfolio becoming dominated, over time, by the riskier growth assets component of the portfolio and to keep you within your emotional tolerance for falls, your financial capacity to weather them and your need to take risk in the first place.

Logically, the reverse also applies; at times like these the proportion of equities in your portfolio will have fallen below their long-term target.  This matters because your portfolio now has too little risk and it will be harder for the growth assets remaining to recoup the falls in value when markets eventually recover.

We can work that idea through with a simple example.  Imagine you own a £10,000 portfolio split 50% (£5,000) into growth assets and 50% into defensive assets.  In the growth assets portion, you own 50 units of a global equity fund priced at £100 per unit.  Growth assets fall by 40%.  Let’s assume your defensive assets are unchanged in value.  You still own 50 global equity fund units, but they are now priced at £60.  Your growth-defensive split has moved from 50/50 to 37.5/62.5.  Time to rebalance.

Figure 1: Market falls leave you underweight growth assets

Rebalancing

Source: Albion Strategic Consulting

Rebalancing i.e. buying equities to realign the portfolio with its allocation target, helps to ensure a quicker recovery back to where you started.  This is because the breakeven price of your equity holdings is now lower.

So, let’s now assume that you rebalance by taking £1,000 from your defensive assets and buying growth assets to get you back to a 50/50 split (left hand grid below).  You can buy 16.7 units at £60 with the £1,000 raised.  To get your portfolio back to its starting value of £10,000 your now 66.7 global equity units need to rise 50% to £90 per unit (middle grid).  However, an un-rebalanced portfolio (right hand grid) only rises to £9,500 with this 50% rise.  In fact, to get back to a portfolio value of £10,000 and un-rebalanced portfolio requires a rise of 67% in the global equity units to £100.

Figure 2: Rebalancing helps the portfolio to recover faster

Rebalancing

Source: Albion Strategic Consulting

Even if the markets fall again after rebalancing, the opportunity exists to rebalance again, likewise further reducing the rate of return required to get back to where you were compared to un-rebalanced portfolios.  That takes courage and discipline, when your emotions are telling you to do the opposite.

The issue of a potential rebalance on the back of large market falls is certainly being considered and don’t be surprised if we raise this with you.  You now know why.  Remember, if you are drawing an income from your portfolio, withdrawing from bonds can get you closer to your target.  Likewise, if you have incoming cashflows, this too can be used to buy growth assets.

As David Swensen, CIO of Yale University’s Endowment and one of the world’s most highly respected institutional investors states[1]:

‘The fundamental purpose of rebalancing lies in controlling risk, not enhancing returns.  Rebalancing trades keep portfolios at long-term policy targets by reversing deviations resulting from asset class performance differentials.  Disciplined rebalancing activity requires a strong stomach and serious staying power.’

Do you really need to rebalance?  The answer for most investors is likely to be ‘yes’ when the time comes.  If we feel a rebalance is necessary, we will be in touch to discuss this with you.

As ever, please feel free to give us a call if you have any questions.

Risk warnings

This article is distributed for educational purposes only and must not be considered to be investment advice or an offer of any security for sale. The reference to any products is made only to make educational points and must, in no circumstances, be deemed to be any form of product recommendation.
This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

[1]    Swensen, D., (2000) Pioneering Portfolio Management.  New York: The Free Press

Want to Win in Negotiations? You’ll Need These Three Tools

Laid out in this article are the three key tools you need to master in order to win in negotiations.

Over the years we’ve observed that success – in business and in life – often results largely from knowing what skills work extremely well and then practising those skills, a lot.

That seems to be especially true when it comes to negotiating. You can almost always get what you ask for – if, that is you are able to ask the “right” way. And we find that highly successful self-made multimillionaires, high-caliber professionals and other high achievers are typically extremely skilled negotiators.

  • It’s important to understand the full range of issues at play during a negotiation.
  • A mindset that seeks a win-win outcome is ideal.
  • Know your need and how to “read” the other side.

Click the image below to read the full article:

How to Win in Negotiations

Other notes and risk warnings

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

 

Don’t Leap Before You Look! The Benefits of Thoughtful Action

This article explores the benefits that come with the use of thoughtful action along with how quick-thinking is perceived and rewarded.

When people are confronted with adversity, opportunity or both, they often react quickly – with the intention of dealing with the situation rapidly and moving forward. These reflexively gut-driven responses are often rewarded by our culture, which praises the “fast-acting-do-er” who “gets the job done” or “puts out fires.”

Trouble is, rapid action can often result in adverse outcomes.

  • Quick responses to problems and opportunities don’t always lead to good results.
  • Thoughtful action rooted in your goals and in deep insights into a situation can create much better outcomes.
  • Accept your emotional reactions to big-moment situations – but don’t let them drive your decisions.

Click the image below to read the full article:

Other notes and risk warnings

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

Déjà Vu All Over Again

Below is an interesting and insightful take on investment fads and their future, from Dimensional.

Investment fads come and go. Letting short-term trends influence your approach may be counterproductive to pursuing your financial goals.

Investment fads are nothing new. When selecting strategies for their portfolios, investors are often tempted to seek out the latest and greatest investment opportunities. Over the years, these approaches have sought to capitalise on developments such as the perceived relative strength of particular geographic regions, technological changes in the economy, or the popularity of different natural resources. But long-term investors should be aware that letting short-term trends influence their investment approach may be counterproductive. As Nobel laureate Eugene Fama said, “There’s one robust new idea in finance that has investment implications maybe every 10 or 15 years, but there’s a marketing idea every week.”

Click the image below to read the full article:

Deja Vu Investment Fads

Other notes and risk warnings

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

The Pain and Pleasure of Diversification

Could’ve, would’ve, should’ve!

It is human nature to look at an investment that has done particularly well and wish you had been invested in it. We all risk being dragged into ‘if only’ mind games: ‘If only I had put a £10,000 into Amazon in 2003, I’d be retired by now’ 1. ‘If only I had bought Bitcoin at £1…’. These thoughts are dangerous to investors, as this fear of missing out (FOMO) can tempt them into taking speculative risks, often based on a rear-view mirror perspective. Concentrated risks have concentrated outcomes, both good and bad.

We have a lot of respect for the fund manager Neil Woodford, but anyone reading the news lately will have seen that his concentrated, high conviction, long-term strategy takes a lot of living with, which few investors seem to have the stomach for. His fund, which peaked at above £10 billion, has less than £4bn in it today and the doors are currently closed to new money and withdrawals. Concentration risks are real.

A powerful insight into the dangers of owning a concentrated portfolio can be found in a piece of research on the US market from 1927 to 2015 2. Of the 26,000 companies that have been listed on the US exchanges, only 36 made it through the whole period. The total wealth of $32 trillion generated over the period was entirely accounted for by just 4% of companies. The market as whole – the good and bad in aggregate – delivered an annualised return of nearly 7% after inflation p.a. i.e. investors doubled their money roughly every 11 years, over this period. That’s a pretty good outcome and a direct consequence of being diversified.

The difficulties of trying to time markets or to pick companies, sectors or managers, in the face of little evidence that professional investors have persistent skill in these fields suggests that a rational investor should eschew such approaches and seek to place their investment eggs across a wide range of baskets.

Diversification is ‘always having to say you are sorry’

The challenge with owning a diversified portfolio is that sometimes investors fail to look at the big picture, diving into the detail of their portfolio valuation to pick out the fund that is not performing well, and possibly moaning about it. Underperformance does not mean that it is a bad fund or a bad strategy or a bad manager, particularly when systematic, low cost funds are used in the portfolio to capture market returns. It just means that some markets (or parts of markets) are zigging while others are zagging – the very essence of diversification!

A diversified portfolio is not always easy to live with, as there will always be something you don’t own that is doing better than the portfolio and always something in the portfolio that is doing poorly. So, if your adviser has to say they are sorry sometimes about an underperforming fund always remember that a) they are not responsible for market returns and b) they are acting in your best interests by making you remain diversified and stick with the programme.

1 In 2003 Amazon’s stock price fell as low as $7 per share. At the time of writing, the share price is over $1775
2 Bessembinder, H., (2017) Do Stocks Outperform Treasury Bills? WP Carey School of Business, Arizona State University.

Other notes and risk warnings

Risk warnings

This article is distributed for educational purposes only and must not be considered to be investment advice or an offer of any security for sale. The reference to any products is made only to make educational points and must, in no circumstances, be deemed to be any form of product recommendation.

This article contains the opinions of the authors but not necessarily DonaldWealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed.

It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice. Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset ManagementLimited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

 

 

Costs Really Do Matter

“Performance comes, performance goes. Fees never falter.”

Warren Buffett, investment legend, Chairman, Berkshire Hathaway (2018 Letter to Shareholders)

Costs, time and compounding are an insidious mix

It is a shame that human beings are so poorly wired to be good investors.  We have many deep-seated biases and behaviours that, whilst once useful to survive in the wild, do us a great disservice when investing. One area of weakness is our poor grasp of the exponential impact of compounding that can work both for and against us.

Imagine three different portfolios that deliver returns of 1%, 3% and 5% per year after inflation, but before other costs, over a period of 30 years: £100,000 invested in each would result in a growth of purchasing power to around £135,000, £240,000 and £430,000 respectively.  Seemingly small differences in the compound rates of return (geometric returns), turn into large differences, in terms of financial outcomes. That’s one of the great positives of a disciplined and patient approach to investing – small returns turn into big numbers, given time.

On the other side of the coin, costs – when compounded over time – eat away at these market returns to a far greater degree than many investors ever imagine.  Let’s compare two managers who deliver 3% gross (before fees) above inflation, where Manager A has costs of 0.25% and Manager B has costs of 1.00%. We plot the purchasing power impact of these different fee strategies on outcomes, across time, in the chart below.  As you can see, costs matter a great deal; an investor in Manager B’s fund is over £40,000 worse off than an investor with Manager A’s fund over 30 years. Put another way, you end up one third more wealthy selecting Manager A over Manager B.

Figure 1: Compounding is a powerful concept (1)

costs

(1) Compounding: Starting amount X ((1+rate of return)^number of years), where ^ is ‘to the power of’.

 

As Jack Bogle would say: ‘In investing, you get what you don’t pay for’. A pound of costs saved is more valuable than a pound of performance gained because you reliably get its benefits every year.

Risk warnings

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

 

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

 

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

The Two Types of Professional Networks You Need to Become Super Rich

There are two types of professional networks that you need in order to support your business and gain an abundance of wealth. Expansive networks and nodal networks are vital to becoming super rich.

  • Top entrepreneurs use expansive networks of many people and nodal networks with just a few contacts to generate tremendous wealth.
  • Nodal networks are tougher to build – they require deep relationships with exactly the right people – but they offer a tremendous return on investment of your time and energy.
  • Leveraging the connections of your own network members can work like rocket fuel – rapidly accelerating your success.

This article explains exactly what these networks consist of and how they could benefit you.

Click the image below to read the full article:

Professional Networks

 

 

 

 

 

 

 

 

 

 

Other notes and risk warnings

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

How to be the world’s worst investor! (Common and costly mistakes to avoid)

Question: “How do you make a small fortune?”
Answer: “Start with a large one!”

The $2 million dollar question

As you can see, the investment world is not particularly strong in the joke department. Unfortunately, this old joke is on us – the investor!

It is perhaps alarming to realise that a huge amount of wealth is destroyed by investors, as they fall into the traps set, either by human nature, or by those working in the investment and advisory industry itself. The harsh fact is that the wealth that is needlessly forgone will have a significant impact on their lifestyles and the opportunities that wealth brings to them, their families and their communities.

Let’s try and put some numbers on this wealth destruction: an annual study in the US(1) compares the returns that the US equity market has delivered over the previous 20-year period, against the returns that the average investor has made by investing in US equity funds. The result: for the period to the end of 2008, the market delivered a return of 5.3% after inflation on average per year (that is the compound rate of return). Did the average investor receive a comparable return? Not at all! In fact, the average investor managed to lose 1% a year after inflation, thereby depleting the amount of goods and services their investments could purchase.

If we transfer those return numbers into dollars and cents (as it is a US study), we can gauge the true level of wealth forgone by many millions of Americans. Imagine yourself in their shoes – you invested $1 million in the market in 1988, in a fund that sought to deliver the return of the market as closely as possible (these are known as index tracker or passive funds). You forget about it until the end of 2008. Your return, after fund costs – of say 0.3% per year – and inflation, was 5% per year. Your $1 million was now worth $2.7 million in purchasing power terms (i.e. the goods it could buy). On the other hand if you had made the same mistakes as the average American investor, you would have turned your $1 million into $800,000. That is an enormous opportunity cost of almost $2 million.

Figure 1: Throwing money away

wealth destruction - purchasing power effect graph

Source: Dalbar (2009)

We should not become complacent here in the UK, as a recent study(2) revealed that the average investor in UK funds received a return of around 4% below the market, per annum

Investment Trivia

The best performing US mutual fund over the 10 years to the end of January 2010 (The CGM Focus Fund) delivered a return of 18% per annum, yet the average investor received a return of minus (yes, minus) 13% a year.

Avoiding key mistakes

The encouraging truth is that being aware of the mistakes that many investors make and avoiding the traps that are set, allows you to take some simple steps to capture as much of the upside that is on offer from the markets, and that is rightly owed to you for the risks YOU take with YOUR money. These words are emphasised as you need to protect your interests from those in the investment industry whose interests may not be sufficiently aligned with your own. So what are the $2 million mistakes?

Mistake 1: Being human!

Unfortunately, we have been bowled a googly* by evolution that makes us susceptible to making poor investment decisions. While the human mind is an incredible thing, it has evolved a number of biases that, while useful as survival tools for everyday life, are the very basis for the wealth destruction that is so often evident.

A deep seated sub-conscious battle is constantly played out in investors’ minds, pitting greed and the desire for reward, against the fear of uncertainty, loss and social isolation. Its manifestation is irrational and emotionally driven investment decision making. Your emotions and innate biases – of which you may not be aware, such as over confidence, inertia, seeing patterns and trends where none exist, the desire to avoid regret, and going with the herd – can make you susceptible to poor decision making.

The whip-saw effect

Humans have survived by applying what they have just experienced and extrapolating that into the future – successful hunting grounds this year are likely to be good next – but this makes us all susceptible to making bad investment decisions. Mix in a bit of subconscious greed and the result is the temptation to chase ‘winners’, both in terms of markets – such as gold and emerging market equities – for no other reason than they are going up (or because the case is backed by a seemingly plausible story), and to chase brightly shining ‘star’ managers and funds.

The trend is not your friend

The problem is that the past is not a good guide to the future, as every piece of investment literature is obliged to state, by the Financial Services Authority (FSA). Yet every Sunday paper you pick up will have a money section full of tables and commentary on the best funds and managers, usually based on the past one to three years. Investors are prone to extrapolate these returns into the future. Mix in a propensity for failing to take account of the role that luck plays in short-term fund performance (lucky coin flippers will inevitably exist in these rankings, given that there are thousands of funds in existence) and it is easy to see how you can get seduced into believing that the short-term, market-beating performance will inevitably continue long into the future – it rarely does (3).

Figure 2: The cycle of wealth destruction

the cycle of wealth destruction

Up like a rocket – down like a stick

The problem is that markets inevitably go down as well as up, and managers run out of luck. The reversal causes concern, discomfort, fear and finally panic selling. The result is a buy-high, sell-low strategy – a recipe for destroying that $2 million of potential wealth.

Looking at the CGM Focus Fund, mentioned in the Investment Trivia box, we can see an extreme example of these human weaknesses in action: in 2007 this commodity-based fund returned 80% and, as a result, in 2008 investors poured a staggering $2.6 billion into the fund. Commodity markets reversed and the fund fell by almost 50% and investors withdrew around $750 million. Buy high – sell low!

Mistake 2: Not understanding the game being played

Through no fault of their own, many investors have not stopped to think about the game in which they are participating. Imagine that two investors own the whole market. The first picks and owns all the companies that did better than the market. By definition, the other investor must own all the stocks that failed to beat the market. One investor’s gains must be funded by another’s losses – trading in the markets is a zero-sum game (before costs).

That would not matter if skilled investors, who either must have better information than others or use the same information better, could turn this information asymmetry into profitable market-beating returns. You could buy their funds.

We believe that markets actually work pretty well, despite what professional fund managers will claim(4). Mispriced share ‘bargains’, on which those fund managers, pedalling the promise of market-beating returns, should thrive (otherwise known as ‘active’ managers), seem to be short-lived or hard to exploit profitably once costs are taken into account. There is no doubting the talent and hard work of those working as fund managers in the City, but the sad fact is that from the long-term evidence of their funds, most would provide a better service to their clients by staying at home!(5)

The evidence would seem to suggest that you should not try to beat the market, but simply try to capture as much of the return that capitalism can deliver in reward for owning companies (equities) or lending your capital (bonds), by using low-cost index tracking (passive) funds.

Mistake 3: Ignoring the maths

That leads us to the question of maths. One of the reasons why many active managers fail to achieve their marketbeating promise is that they have to overcome the costs of investing. These include the fees they charge for managing the fund and other expenses that are set against the fund’s performance. This ‘on-the-road’ cost of investing is known as the Total Expense Ratio or TER for short. On top of these costs are the costs of buying and selling securities held by the fund (turnover).

Let’s start with some simple adding

ignoring the maths leads to wealth destruction

That does not sound too bad if the markets have gone up by 30% in one year. However, in the context of long-term return history, equities have delivered a return after inflation of around 5% p.a. over the past 111 years(9).

Now for some simple percentages

1.9% is almost 40% of the 5% that equities have returned, over the long term, after inflation. In other words the investment industry participants have helped themselves to a large part of your wealth, yet you have taken all the risk, and it is your money and future at stake.

Now for some multiplication

Imagine that two identical funds exist and that they own all the shares in the UK equity market. The only difference is that Fund A has a cost structure of 1.9% p.a. and Fund B has a cost structure of 0.3%8 p.a. Let’s assume that the UK equity market delivers 5% p.a. over the next 30 years and you invest £100,000 in each.

Your investment in Fund A rises to about £250,000 – not bad until you look at Fund B which delivered you a little under £400,000 – a difference of £150,000!

The power of the mathematics of compounding (calculating interest-oninterest) combined with time is immense; small differences get magnified into large final outcomes. Costs really do matter in investing – the lower the better.

And finally some probabilities

The question you need to ask is: what is the probability that a manager will deliver skill-based, market-beating returns over the long-term? The empirical evidence indicates that we are probably looking at around 2%-3% of them3 . Remember that these managers have been identified with hindsight. The next question is: what then are the chances that you or an adviser can pick the few truly skilled managers today, who will deliver over the next 30 years? Answer – absolutely minimal. As Jack Bogle, one of the pioneers of index investing states “Don’t look for the needle, buy the haystack!”

At the end of this maths 101, it is probably easy to see the lesson that emerges – costs really do matter in the investment game. Again to quote Jack Bogle “In investing you get what you DON’T pay for!”

Good investing is not rocket science

At its simplest, investing is quite straightforward. You only have two things you can do with your money: buy part ownership in companies (equities), with the reward of dividends and hopefully share price rises; or lend your money to a government or a company, with the expectation of receiving interest and your money back.

It is not a get rich quick fix, but a slow controlled preservation of the purchasing power you have accumulated, and hopefully achieving some growth too, by taking, managing and living with specifically chosen and understood risks, accessed in a low-cost and effective manner.

A well-thought-through and evidence-based approach to investing should deliver better outcomes, over time. Perhaps most importantly we all need to hold our nerve when markets are either overly exuberant or in the depths of despair, and avoid the whip-saw of emotions and human biases.

If we can achieve that for our clients, we will have earned our annual relationship fee several times over.

Take-home points

  • Investors needlessly destroy wealth.
  • Emotions and human biases make us prone to poor investment decisions.
  • We ignore investing costs at our peril.
  • Sensible portfolio structures, robust process and hand holding by an advisor help to mitigate these risks.

We hope that you have enjoyed this article. Please do not hesitate to call if you have any questions or comments on it.

*For non cricketers, a ‘googly’ is a cricket ball bowled as if to break one way that actually breaks in the opposite way, in order to deceive the batsman.

End notes

  1. Dalbar Quantitative Analysis of Investment Behaviour, 2009
  2. Schneider, L. (2007), Diploma thesis: Are UK fund investors achieving fund rates of return? Submitted in July 2007, Fachhochschule Kufstein, Tirol, Austria.
  3. Bogle, John, C., (2007), The Little Book of Common Sense Investing, John Wiley & Sons, NY: NY.
  4. The Efficient Markets Hypothesis was developed by Professor Eugene Fama. It suggests that markets work effectively, incorporating all public information in a share price, which is the best estimation of a company’s true value. Prices change on new information and, as such, market movements are unpredictable and random. Mispricings are unpredictable and are rarely exploitable. The empirical evidence on the persistent failure of most professional investors to beat the market supports it. Seminal works: 1) Eugene F. Fama, “Efficient Capital Markets: A Review of Theory and Empirical Work,” Journal of Finance 25, no.2 (May 1970): 383-417. 2) A Random Walk Down Wall Street, by Burton Malkiel.
  5. Many studies reveal the same message. They are recorded in our [Investment Process Manual].
  6. The average UK All Companies actively managed fund has a total expense ratio (TER), which comprises the Annual Management Charge (AMC) and other fixed costs that can be offset against fund performance, of around 1.6% (Lipper 2009). Within that there is around 0.5% trail commission passed to commission-based advisers each year. Another 0.3% represents payments to fund platforms to cover the cost of holding the assets for the client. To make a fair apples-to-apples comparison, these costs have been omitted from the ‘all-in’ calculation.
  7. Other costs that are a drag on performance, relate to the decisions to sell and buy shares. The average turnover is around 100% of the portfolio a year (SCM Private 2010), which is based on estimated round trip costs (Albion estimate 2010) to sell and buy a share in the UK of around 1% (0.5% of which is stamp duty). This implies that the average active fund incurs around 1% of trading costs a year.
  8. Investors can access the UK equity market these days for around 0.2%. Index funds tracking the broad market have very low turnover and associated costs, estimated at 0.1% a year.
  9. Barclays Equity Gilt Study (2010)

 

Other notes and risk warnings

This article contains the opinions of the authors but not necessarily Donald Wealth Management (the Firm) and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Donald Wealth Management’s services. Donald Wealth Management strongly suggests that no investor should act on any of these ideas without first seeking financial advice.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of an investment is not guaranteed and on encashment you may not get back the full amount invested. Errors and omissions excepted.

Donald Wealth Management is a trading style of Donald Asset Management Limited which is authorised and regulated by the Financial Conduct Authority in the United Kingdom (FRN: 223784). Donald Asset Management Limited is registered in England and Wales under Company No. 4675082. The registered office address of the Firm is: Stable End, 12 Heather Court Gardens, Four Oaks, West Midlands, B74 2ST.

A Successful Wealth Protection Event

We would like to thank all those who attended our Wealth Protection Event in March. The event, which was hugely successful, took place on Thursday 30th March at Weston Park in Shifnal, Shropshire, starting with a champagne reception and ending with afternoon tea in the Orangery.

During the afternoon, we gained an interesting insight into ‘The Principles of Successful Investing’ – a talk by David Swanwick of Dimensional Fund Advisors, and ‘How to Protect Yourself from Cyber Crime’ – a talk by Phil Oakley of Outserve Ltd. The slides from Phil’s presentation are below. Click to view.