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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.

Brexit and Your Portfolio

Whichever way one voted, it is hard not to be dismayed by the shambles that is Brexit, concocted by all sides. In the event that any deal agreed gets voted down in Parliament, or there is no deal, there is a material chance that the government could fall. One or both of these events would come with great uncertainty.

We set out three key investment risks relating to Brexit and how sensible portfolio structures can mitigate them.

Risk 1: Greater volatility in the UK and possibly other equity markets

In the event of a poorly received deal or no deal, it is certainly possible that the UK equity market could suffer a market fall as it tries to come to terms with what this means for the UK economy and the impact on the wider global economy.  A collapse of the Conservative government and a Labour victory would add further uncertainty.

Risk 2: A fall in Sterling against other currencies

In 2016, after the referendum, Sterling fell against the major currencies including the US dollar and the Euro.  There is certainly a risk that Sterling could fall further in the event of a poor/no deal.

Risk 3: A rise in UK bond yields (and thus a fall in bond prices)

The economic impact of a poor/no deal and/or a high-spending socialist government could put pressure on the cost of borrowing, with investors in bonds issued by the UK Government (and UK corporations) demanding higher yields on these bonds in compensation for the greater perceived risks. Bond yield rises mean bond price falls, which will take time to recoup through the higher yields.

Mitigant 1: Global diversification of equity exposure

Although it is the World’s sixth largest economy (depending on how you measure it), the UK produces only 3% to 4% of global GDP, and its equity market is around 6% of global market capitalisation.  Well-structured portfolios hold diversified exposure to many markets and companies.  Changing your mix between bonds and equities would be ill-advised.  Timing when to get in and out of markets is notoriously difficult. Provided you do not need the money today, you should hold your nerve and stick with your strategy.

Mitigant 2: Owning non-Sterling currencies in the growth assets

In the event that Sterling is hit hard, it is worth remembering that the overseas equities that you own come with the currency exposure linked to those assets.  Remember too that a fall in Sterling has a positive effect on non-UK assets that are unhedged.  The bond element of your portfolio should generally be hedged to avoid mixing the higher volatility of currency movements with the lower volatility of shorter-dated bonds.

Mitigant 3: Owning short-dated, high quality and globally diversified bonds

Any bonds you own should be predominantly high quality to act as a strong defensive position against falls in equity markets.  Avoiding over-exposure to lower quality (e.g. high yield, sub-investment grade) bonds makes sense as they tend to act more like equities at times of economic and equity market crisis.

Some thoughts to leave you with

Even if you cannot avoid watching, hearing or reading the news, it is important to keep things in perspective.  The UK is a strong economy with a strong democracy.  It will survive Brexit, whatever the short-term consequences that we will have to bear, and so will your portfolio.  Keeping faith with both global capitalism and the structure of your portfolio and holding your nerve, accompanied by periodic rebalancing is key.  Lean on your adviser if you need support.

‘This too shall pass’ as the investment legend Jack Bogle likes to say.

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.

If I Were a Rich Man…

We tend to regard wealth as financial assets, large houses, and nice cars accumulated through a life of hard work.  Yet that is to view wealth in narrow terms; on the very day we are born we are wealthy in terms of our human capital, or in other words, the present value of all the future earnings that we will generate over our working lives.  This needs to be reflected in how we invest during the accumulation phase of investing.

As younger people have a long time to go before they will need the money, the advice they receive is often that excess earnings should be invested predominantly in equities.  A subtler approach takes into account the attributes of each person’s human capital, which ranges from bond-like to equity-like in nature.  Take for example a university professor and a fin-tech entrepreneur; the former has stable income, linked to inflation and job security; the latter has little income stability and, most likely, a high correlation to the equity markets. The professor’s human capital acts like a bond, the entrepreneur’s as an equity.

So, if they are both 40 years old and have the same level of financial capital, should they invest in the same way?  Intuitively, the answer is no.

“Human capital should be treated like any other asset class; it has its own risk and return properties
and its own correlation with other financial asset classes.”

Ibbotson, Milevsky, Chen and Zhu (2007)[1]

Those with more bond-like human capital could well take on more risk and those with more equity-like human capital should, perhaps, take on less risk with their financial capital.  Ironically, it is also possible that those who choose steady, stable jobs may have lower tolerance to losses than the entrepreneur, and vice versa.  One can see the risk of this scenario.  Additionally, two partners may also have different levels of risk in their human capital. Imagine a professor married to an entrepreneur; together they form a balanced portfolio between bonds and equities and their investable portfolio of financial capital should reflect this.

Figure 1: How human capital attributes influence asset allocation

Lower equity content in portfolio Higher equity content in portfolio
Low job and earnings stability High job and earnings stability
Low earning flexibility High earning flexibility
High correlation of earnings to equities Low correlation of earnings to equities
Low earning capability High earning capability (replenish losses quickly)

 

Source: Albion Strategic Consulting

Cash-flow modelling can help those in the accumulation phase of investing to understand the financial impact of changes to their human capital.  Owning sufficient life cover to protect the outstanding human capital should be an important part of the discussion.  It is difficult to see how a stockbroker or investment manager can structure a portfolio sensibly, particularly where the investor still has substantial human capital, without the insight into, and modelling of, the client’s total asset picture.  No financial portfolio is an island.


[1]       Ibbotson, Milevsky, Chen and Zhu (2007), Lifetime Financial Advice: Human Capital, Asset Allocation and Insurance, Research Foundation of CFA Institute publication.

 

Other notes and risk warnings

This article is distributed for information purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author 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.

The past is not indicative of future results and no representation is made that the stated results will be replicated. 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 foundation stones of good investing

Scales weighing buy and sell options to illustrate investing decisionsInvesting is the process of delaying consumption from today to some time in the future and employing that money in the meantime in the markets to grow at a rate at least in line with inflation, but preferably more.  Investing money well requires a logical and robust framework on which to build a lifelong investment programme. Ten foundation stones provide the solid base on which to build such a programme.

Foundation stone 1: Have faith in capitalism and confidence in the markets

Capitalism is an adaptive, robust economic system that has delivered incredible developments to the benefit of mankind.  It may not be fair, but it has helped to drag many of the World’s poorest out of abject poverty over the past century.  It creates wealth.  The markets are an efficient mechanism for rewarding those who provide capital to those engaged in the pursuit of wealth creation.  

Foundation stone 2: Accept that risk and return go hand in hand

One of the inescapable truths of investing is that to achieve higher returns, you have to take on more risk (1).  That seems logical enough, but you would be surprised just how many investors seem to think that it is possible to get high returns with low risk.  The one thing we know for sure about risk is that if an investment looks too good to be true, it probably is.  

Foundation stone 3: Let the markets do the heavy lifting

In investing, there are two main sources of potential returns.  The first is the return that comes from the market and the second is the return generated through an investor’s skill. There are two main ways in which an investor – using their skill – can try to deliver a better return than the market return: one is to time when to be in or out of the markets (market timing), the other is to pick great individual stocks (stock picking).  Empirical evidence suggests that trying to beat the market is a tough game, with very few long-term winners.  As one cannot control the return of the market, and returns from skill are rare, the structure of your portfolio becomes key.

Foundation stone 4: Be patient – think long-term

There is no easy or quick way to investment success.  In the short-term, market returns can be disappointing. The longer you can hold for, the more likely the returns you will receive will be at worst survivable, and hopefully far more palatable.  It is time that allows small returns to compound into large differences in outcome for the patient investor.  If you want to be a good investor, you have to be patient.  Impatient investors tend to lose faith in their investments too quickly, with often painful consequences.  

Foundation stone 5: Be disciplined

Patience and discipline are close bed fellows.  Once you realise that to generate good long-term returns takes time, patience and belief in the markets, it is essential to put in place the discipline to stop yourself succumbing to impatience and ill-discipline.  Discipline comes in many forms: sticking to the principles above; constructing well-researched and tested portfolios that should weather all investment seasons relatively well; not chasing investments that have gone up dramatically, but sticking with the logical reasons for not owning them in the first place; and the discipline to not become despondent about short-term, unimportant market noise, and to focus on your long-term strategy.

Foundation stone 6: Build a well-structured portfolio

Once you accept that returns come from markets and are rarely enhanced by the judgemental approaches of professional managers of market timing and stock picking, it is evident that structuring a well-thought-out mix of different investments (referred to as asset classes) should sit at the heart of your investment programme. Your long-term portfolio structure will dominate the investment returns obtained during your investment lifetime (2).  

Foundation stone 7: Use diversification to manage an uncertain future

Not putting all of your eggs in one basket is an intuitive and valuable concept.  No-one knows what the future holds and owning a highly diversified portfolio is the key tool that we have to make sure that we are prepared for whatever the markets throw at us over time. It brings its own challenges.  Inevitably there will always be one or two parts of the portfolio that are doing well, but one or two that are not.  The patient and disciplined investor knows that there is little point in knee-jerk responses, and that this is simply the way that markets are.  The impatient and ill-disciplined will seek to change their strategy.  More fool them.

Foundation stone 8: Avoid cost leakage from your portfolio

Costs eat away at the market returns that you should be gathering for yourself.  Small differences in costs will compound into large differences over extended periods of time.  Investment industry costs are high, particularly those related to judgemental (active) managers.  If one takes two portfolios with the same gross (pre-cost) returns – one with a low cost of 0.25% a year and the other with a high cost of 1.5% a year – the low cost strategy will, on average, end up with a staggering 65% more money in the pot over 40 years (3).

Foundation stone 9: Control your emotions by adopting a systematic approach

Unfortunately, evolution has hard-wired the human brain to be particularly poor at making investment decisions. Evidence of wealth destroying, emotion-driven decision making is plentiful, as impatient and ill-disciplined investors have a propensity to chase fund managers, and markets that have previously performed well, and sell poorly performing investments.  Buy-high, sell-low is not a good investment strategy.  Research (4) reveals that this bad behaviour may cost investors around 2.5% per annum, on average.  Given that equities have only returned around 5% above inflation, on average, that is a material erosion of potential wealth.  

Foundation stone 10: Manage risks carefully across time

Our approach to investing positions us as risk managers, rather than performance managers as advisers have traditionally been.  Keeping the risk in your portfolio at an appropriate level is achieved through ‘rebalancing’ periodically back to your long-term portfolio strategy. Rebalancing involves selling out of better performing assets and buying less well performing assets i.e. selling, rather than buying ‘hot’ performing asset classes.   Fund selection and due diligence and the ongoing governance of the investment process are all important risk management functions.

Employing a systematic investment approach – like the one we have developed – provides the discipline and objectivity that is required to avoid the pitfalls that all investors inevitably face.  These foundation stones certainly make investing far simpler and easier, but never easy.  

(1) Sharpe, William F. (1964). ‘Capital asset prices: A theory of market equilibrium under conditions of risk’, Journal of Finance, 19 (3), pp. 425-442.

(2) Brinson, Gary P., Hood, L. Randolph, and Beebower Gilbert L., (1986) ‘Determinants of Portfolio Performance’, Financial Analysts Journal, vol. 42, No. 4, pp 40-48.

(3) Sharpe, W. F., (2013), The Arithmetic of Investment Expenses, Financial Analysts Journal, Volume 69 · Number 2, 2013 CFA Institute.

(4) Mind the Gap 2014 by Russel Kinnel, Morningstar. http://news.morningstar.com/articlenet/article.aspx?id=637022

Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author 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.

Getting investing right is difficult; please speak to us before you act independently.

Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of a unit linked 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.

 

Our Investment Process Explained: Video

This video gives you an overview of our investment process, i.e. how we invest our clients’ monies. It details the approach we have adopted for our clients and and explains why we have chosen this route. We hope it proves useful as you start your journey learning about the different types of investment options that are available to you. Please seek professional advice before making any investment or financial transaction.

If you would like a second opinion on your current investment strategy, please feel free to contact our office on 0121 3088034 or contact us here.

Annual portfolio re-balance taking place in March

iStock_000006849616Medium

It’s that time of the year when we process the annual re-balance of our client portfolios. This ensures the portfolios remain correctly structured for the risk level we have selected for you. We also use it as an important opportunity to make any changes to the funds we are using.

It is essential that you sign and return the annual re-balance approval page as soon as possible (a pre-paid envelope has been included with your report).

If you have any queries with your report just let us know.

Rebalancing should be driven primarily by the desire to maintain your portfolio at the appropriate level of risk that you wish and need to take on. While it is postulated that frequent rebalancing can produce a rebalancing bonus, this is not guaranteed and should not be the driver of the process.

At times it can take a strong stomach to sell out of rising markets and to buy into falling markets, yet this provides a contrarian, buy-low, sell-high strategy, which maintains the portfolio at a risk level chosen specifically by you in the first place for its survivability.

As such, the annual portfolio re-balance process needs to be defined and disciplined. At the re-balance we will also ensure the portfolio has sufficient cash available to fund the plan charges and any income withdrawals for the next 12 months. If you have not used all of your ISA allowance for this tax year we have recommended moving funds from your GIA across to your ISA.

Other notes and risk warnings

This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author 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. Past performance is not indicative of future results and no representation is made that the stated results will be replicated. The value of a unit linked 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.