How the uber-talented and wealthy actually invest ..
Now if you’re like me, you kind of endured the previous 450 pages of the book to get to this point.
So it might surprise / disappoint you to hear that I’m not going to deal with this entire section in any detail at all. Why not? WTF!?
Here’s the short answer – it really doesn’t matter what your asset allocation looks like. Much like dieting – a good plan that you stick to will totally out-perform the perfect plan you can’t abide.
Here’s another startling fact. Fees makes more of an impact on your investment pot than the diversification of assets.
But don’t take my word for it. In researching for this blog, I did a lot of reading (books and blogs) and have come to the following conclusions.
Fees & Taxes Trump Allocation
I read a great book entitled Global Asset Allocation – which essentially summarises the whole of Chapter 6 in just a few pages. It’s £2 to buy, easy to read and I highly recommend it. Read a summary of the book.
These are the key takeaways:
All the most famous guru-style strategies had vastly different exposures: some 25 percent in gold, some zero and they ended up being very similar. The spread between these 15 portfolios was less than 1 percent a year.
People spend 90 percent of the time thinking about allocation, when they should be spending 90 percent of the time on minimizing fees and taxes.
The exact percentage allocations don’t matter that much. Make sure to implement the portfolio with a focus on fees and taxes.
So, that expensive mix of investments you paid your IFA for? Turns out that, by virtue of his (or her) fees, that portfolio is statistically unlikely to perform as well as something you self-selected (without a fee).
We took the best performing strategy and compared it to the worst. If you add worst-case fees to the best, it has the effect of transforming it into the worst-performing. Fees are more important than your asset allocation decision.
So, what’s an average UK investor to do? My decision has been to reject going down the IFA route completely, find a low cost platform, and buy a bundled diversified single fund. Here’s why ..
Reject the IFA route
This sounds kind of harsh, but I’ve got pretty vanilla requirements and paying an IFA a retainer of 0.5 – 1% pa of my total invested wealth is enough to make that pot of money not keep up with inflation.
It seems crazy but it’s true and, judging by the shift in investments from active to passive, paying an IFA an ongoing fee is absolute madness. If you believe that a passive, index-tracking approach is the way to go, layering a hefty IFA fee on top of that approach without the hope or promise of ‘above market returns’ is just insane.
I’ve met some IFA’s I really liked (and some I didn’t), but that doesn’t change the maths. The book says to keep fees below 1% – and that’s virtually impossible to do when the minimum an IFA will charge you is 0.5% pa.
An IFA will argue that their fee is more than paid for by the increased return from the investments they cherry-pick for you. While that may be true for some people some of the time, it’s statistically impossible for most people to gain above-average returns most of the time. There have to be winners and losers in this active investment game. My limited experience of active fund management bears that out – my investment didn’t even keep pace with inflation.
If there’s one thing I’m absolutely convinced about through reading this book and my other research, it’s that passive investing via a low cost index fund is the only rational choice I can make. Having made that choice, it precludes me from paying an IFA an annual fee – because that’s enough of a hit to sabotage the returns from the index tracker.
Find a low cost platform
Currently my modest pension pot of £83K is using the Old Mutual Wealth platform. I contacted them recently to find out what I’m being charged for doing absolutely nothing at all – and it turns out that it’s more than it should be. Their charge basis 3 says that I’m paying 0.5% on the first £25K and 0.35% on the rest. So ..
0.5% x £25K = £125 pa
0.35% x (£83K-£25K) = £203
Total annual fees = £328
Average fees = 0.40% AUM
So what’s the big whoop-de-do? By comparison, the Alliance Trust SIPP I’ve set up charges a flat fee of £186 pa. That’s 0.22% compared to Old Mutual’s 0.4%. Oh, and as my pension pot grows (hopefully), that % will shrink – compared to the tiered % fees of Old Mutual Wealth.
Should I care about such trifling sums? Yes. Because as I build up my pension pot, the difference of 0.18% makes all the difference when compounded over multiple years.
Buy a single diversified fund
If you mooch through the different strategies detailed in chapter 6, what we’re looking at is different allocations between equities, bonds, commodities and cash.
If you accept that the actual percentages of asset allocation don’t much matter (but costs do), then finding the most diversified, lowest cost fund becomes the smartest thing to do. That’s pretty much what I’ve come down to.
Vanguard is a company mentioned multiple times in the book – and they are the clear benchmark for low-cost index-trackers. While not a pure index tracker, they have a range of low-cost funds which combine equities and bonds into a single fund – called LifeStrategy.
You choose your risk tolerance from 100% equities to 20% equities, and you choose whether you want the investments to produce an income or whether you’ll automatically reinvest the income. Two decisions, and you’re done.
Personally, I’ve chosen the LifeStrategy 40% accumulation fund, I can buy them via the Alliance Trust platform and I can hold them inside an ISA or SIPP wrapper.
The LifeStrategy funds carry an annual fee of 0.24% pa and, when added to the platform fees of Alliance trust of approximately 0.2%, it means that I can keep my actual fees below 0.5% pa – pretty cool huh? So I’ve definitely minimised fees and because I can hold the LifeStrategy fund inside a SIPP and an ISA, I’ve minimised taxes too.
Is this likely to be the best possible investment strategy? Probably not. But it’s one I can stick to, invest in over time as my income allows and not have to think about.
As Carl Richards points out in The Behavior Gap ..
The goal isn’t to make the ‘perfect’ decision about money every time, but to do the best we can and move forward. . . . Most of the time that’s enough.
(His follow-up book, The One Page Financial Plan is also well worth a read.)
What’s important is to pick a financial strategy, implement it – and forget about it. The real risk isn’t another financial collapse or the ‘markets’ turning against us. The risk is our fickle human nature to sell when we panic and buy when we feel we’re missing out – the worst possible times to buy and sell.
Buying and holding a simple index tracker for the long term is the best way to remove the main source of risk from the whole financial conundrum. Remove yourself.
- Choose it.
- Buy it.
- Forget it.
- Take a look at age 70.
So, that’s what I intend to do .. Well, almost.
Remember that ‘ethical’ problem I hinted at in Chapter 2.6, it’s still an issue for me. What I’ve decided to do is buy and hold the Vanguard LifeStrategy funds for now – until a more ethical alternative comes along.
I’m really excited that I’m not just hoping and waiting for that. I’m making it happen. But it’ll take a while to become reality. In the meantime, I’ll do the LifeStrategy thing.