Why investment reviews are a "no brainer" decision.
Friday 10 October 2008
As I write this blog, the FTSE 100 has crashed below the 4000 level.
Without doubt, investors will be finding their emotions are high. Yet at these times, the investment review has never been as important.
As we know what investors need to do, the decision to review is a no brainer. Yet I recognise that many individuals will feel the only option is to do nothing. Even if it appears crystal clear that action should be taken, often investors do nothing. Sometimes in these situations there needs to be a different perspective, to help your decision making. With this in mind, perhaps these numbers might help you in your thought process.
Let us assume that the future investment return on your portfolio is 10%. Most investors would be happy with 10%. If this is managed in a variety of retail managed funds or insurance bonds, when you actually add up all the explicit and implicit costs, it is possible you may have deducted from your funds over 2.5% per annum. That leaves you with 7.5%.
Lets take say a gross return of say 12%. If you take say 2.5% costs from 12% you may end up with 9.5%.
These are simple numbers that everyone understands. However, before I continue, I would like to make the point that these returns are just assumptions, clearly no one can predict future returns. Yet investment costs have been studied. When looking a retail actively managed funds there is ample evidence to suggest that 2.5% per annum is not unreasonable.
If you want to know more, why not take a look at some of the academic evidence.Here is a link to the various studies
Lets continue. If you think the next 5, 10, 15 years or whatever time period you may wish to consider, that investment returns will be say over 12%, you maybe happy to pay the investment charges you have experienced in the past. In other words, if fees and charges are say 2.5%, then as a percentage of 12% total return, then your costs represent about 20% of the total return. You therefore pay 1/5 of the total return in fees and charges.
Do you consider that fair? That is a question for you to answer.
Of course, simple maths will conclude that if you could reduce those charges, you end up with more of the investment cake. That is good news.
But what if you think returns may be lower, perhaps because you are not as optimistic, and think returns may be 7% per annum, then 2.5% of fees represent 33% of the total return. That is 1/3 of the total return in fees and charges. Not only do you receive less because your expected return is lower, but the percentage of the total returns is higher in charges and fees.
Clearly if you could reduce the cost of investment management, it is in your interest to do so.
My point is straightforward, if you reduce the costs you are paying, you end up with more of the total investment return.
Of course, you may say, your investment management fees are nowhere near 2.5%. Your adviser or fund manager may say they are only 1% or 1.5% per annum. If so, perhaps you could look at a study issued by the FSA. On page 5 is the statement: “One must invest about £1.50 in an actively managed unit trust or through a life office in order to obtain the market rate of return on £1”
Try putting these figures in your calculator over 10, 15 and 20 years and you can work out for yourself what the costs are over time. I think you will find the 2.5% is likely to be on the low side! Bearing in mind also that the average holding period according to the Investment Management Association is 7 years!
I also recognise that some fund providers and advisers will say "you get what you pay for". However, take a look at the academic evidence which suggests many fund management groups do not beat the market return.
Not convinced to take action? Ask whoever is managing your money, whether it is in your pension fund or ISA's or separate portfolio, to write to you detailing the impact of costs on your portfolio. Perhaps ask them to comment on the FSA study and ask how they interpret the results.
We believe in transparency and your investment managers and advisers should have nothing to hide.
posted by Murray Round Wealth Management @ 17:08,
The Authors
Nicholas Round
Nic is the Managing Director of Murray Round Wealth Management Limited, who seeks to ensure the advice provided is truly independent. Based in Shropshire with clients local, national and worldwide, Nic has strived to find the best possible service for his clients needs, by researching and studying the market, trends and philosophies. Nic strongly believes Asset Class Management will bring his clients Financial Freedom, Independence and Happiness.
Kirsty
Kirsty is our communication guru. Managing information requires considerable due diligence and her passion for organisation gives the clarity we all seek. From Shropshire, with a Psychology Degree and much travelling, she is now back in Shrewsbury...and London often, keeping us all at Murray Round focused.
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