Dear Fellow Investor,
Why does the thought of managing their own investments scare people so much? And why on earth do people think that a smooth-talking, commission-driven salesman or woman can do a better job than they can at choosing suitable investments?
Do the plush, comfortable offices they're led into help to steady the nerves? Does the expensive car parked outside lead them to believe that the advisor must be a brilliant investor himself? Does the smell of those smart glossy brochures have some kind of intoxicating effect? Is the coffee drugged?!
I know I'll certainly never forget my first encounter with this strange breed of pseudo-professional: it was about twenty-odd years ago at one of those ideal home and garden exhibitions held in our local town hall. I remember that my girlfriend at the time and I were wondering whether to blow our savings on the latest comfy sofa, when we were approached by a portly middle-aged gent who'd obviously identified us as a couple of likely prospects - just like a shark smells blood in the water...
Anyway, my girlfriend, being far more the trusting type than me, began to warm to this chap's patter as he persuaded her of the benefits of putting money aside in the latest overpriced investment 'product'. And remember that all this detailed discussion about my partner's financial future was taking place in the middle of a crowded hall where the world and his wife could earwig on proceedings. So much for professionalism.
Me being the naturally cynical type, there eventually came a point where I could take it no more. Just at the point where the smiles and the banter looked like they were leading inexorably to the point where Sharkman was going to bare his teeth and make the sale, I interjected with a question. I asked: "And how much commission do you make on the deal?" This put Sharkman right off balance. I remember there was a lot of blustering and obvious anger at my cheek and impertinence. As far as he was concerned, marks...I mean potential clients like us...just weren't entitled to ask probing personal questions about his income in that way. Needless to say, he soon swam off looking for easier prey.
Now I know things have changed a bit since those days and the rules on transparency have been tightened up a bit...but only a bit. I mean, if you've ever come into contact with one of these advisors, how often have they volunteered information about how much they're likely to earn over the lifetime of the product that they've just sold you?
More to the point though, there are plenty of investment vehicles out there which, on average, are cheaper than the ones advisors recommend and, on average, have far better long term performance. So why don't these products get recommended then? The simple and sad truth is that it all comes down to money again - these superior, yet cheaper products don't pay commission to financial advisors. So once again, I say - so much for professionalism.
To illustrate the point, imagine a tale of two car dealerships. At one end of town you've got the local Ford dealership which advertises heavily in the media and has a "special deal" offering you a new Ford Focus for 10, 000. On top of that, though, you'll have to pay an extra 5% commission to the dealer making a total cost to you of 10, 500. Then at the other end of town you have the local BMW dealership. They're in a quiet back-street, they don't advertise heavily, yet remarkably, they're able to offer their new, superior, high performance M3's for only 9000. What's more, they don't charge commission. What's even better than that, these BMWs are often going for an 8-10% discount! So what car would you go for?
In effect, that Ford Focus deal is the type of bog-standard product the "investment professionals" have been offering their unwary clients for years. Obviously, in all those years, they've never breathed a word about the better, cheaper BMW dealer round the corner.
So my question to inexperienced investors out there who are dissatisfied with the service offered by their banks or financial advisors is simple - would you like the investment equivalent of an overpriced Ford Focus, or an underpriced BMW?
If you're still a bit wary of driving that new BMW off the forecourt and want to take a look under the bonnet to see exactly what you're getting for your money, then I don't blame you. Allow me to explain further.
These high performance vehicles of the investment world that I'm referring to are called investment trusts, whereas the Ford Focuses beloved of investment advisors are called unit trusts.
Now there are a few differences in the way these two investment "vehicles" are structured, but I don't intend to bore you with all those details in this particular article. Suffice it to say that, in my view, the only thing that matters in the end is performance.
So why don't we check and see how the average investment trust has performed over the long term compared with the average unit trust. All figures reproduced below are courtesy of www.trustnet.com and you can go and check them yourself if you're in any doubt.
For comparison purposes I decided to pick a popular sector with UK investors, UK equity income, and I measured performance of the top 3 unit and investment trusts in this sector over 10 years. Here's what I found
UNIT TRUSTS 10 YEAR RETURN
1. Invesco Perpetual High Income 144.2%
2. Invesco Perpetual Income 139.6%
3. SJP UK High Income 111.3%
INVESTMENT TRUSTS 10 YEAR RETURN
1. Perpetual Income & Growth 165.8%
2. Finsbury Growth & Income 155.3%
3. Temple Bar Investment Trust 119.9%
As you can see, even the second placed investment trust easily outperformed the first placed unit trust over the last 10 years. If you check other sectors, like global growth, I'm sure you'll find very much the same story - with, of course, the odd minor exception to the rule. Nevertheless, I think I've proved my case - the average investor is far better off buying a lower charging, higher performing investment trust than a dearer, underperforming unit trust. So why don't they do it?
Well, I suppose, the go-it-alone inexperienced investor is still faced with the decision about which investment trust to buy - admittedly, there's a very wide choice out there.
I'd argue, however, that the internet makes this selection process easier than it's ever been. After all, how difficult can it be to do what I've just done, i.e. pick a sector on a free-to-use website like Trustnet and check for the top performing investment trust over the past 5 or 10 years? You could then just buy it online like an ordinary share through a cheap execution-only broker.
For diversification purposes you could even divide your money up between a number of different sectors e.g. property, bonds, commodities, UK equity income and global growth. Granted, past performance is no guarantee of future returns, but that applies to any product your advisor sells you too. And believe me, their selections are very unlikely to outperform anything you can find for yourself on Trustnet.
Admittedly, I prefer to go one stage further by cutting out the lower costs that even investment trusts have to levy and select my own individual shares and commodities (please see my portfolio page to check on how I'm doing so far).
Whatever route you choose though, whether you feel confident enough to go the whole hog like me and select individual shares, or keep some sort of collective safety net by buying investment trusts, it's still much more profitable to simply cut out the middle man altogether, pocket all the money you would have paid in commission and re-invest it in your own future rather than your financial advisor's. When it comes to making those all-important decisions about where to invest for your future security, do you really want to pay a fortune just to have a dodgy salesman hold your hand?
The bottom line here is that the information is out there and the technology to take advantage of it is out there. So why not make it your New Year resolution in 2012 to start using it and save yourself a fortune in the process? An added bonus, of course, is that it will annoy the hell out of your financial advisor.
Happy New Year and Happy Investing
John Mac, The Hands-On Investor.
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