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Advising investors not to believe in active investment strategies

Some of the fees charged by local investment advisors, such as local accountants, seem more than hefty. Particularly when investments are in equities. Often there is a fixed fee of around $300 per month or $3600 per year. There is also often a trailing fee of 1% of the value of the portfolio. Thus on a $1m investment with gross earnings of 5% the total annual fees would be $13,600 which, ignoring taxes, would be 25% of the total return. A big slab since it would now take about 20 years for your investment to double if all returns were reinvested whereas it would take only 14 years without the fees.
 
An alternative might be to charge clients $50 for a copy of Burton Malkiel’s A Random Walk Down Wall Street*, and a once-and-for-all $500 fee for assistance in opening up, for example, an efficient CommSec account**, along with a brief introduction to the Vanguard no-load mutual funds, exchange traded funds or to the low-load mutual funds such as Argo Investments or Milton Corporation. Capitalized over 20 years the transactions cost of doing this would fall from 25% of the investor’s total return to a tiny fraction of 1%. Moreover, this move is consistent with almost all evidence on equity markets that passive investment strategies outperform active management.  Should re-tool as a low-cost financial advisor and do this? Probably not although anyone else is free to pursue this approach. 
I mention this because, as an economist, I am often asked for financial advice.  My response is that I have no investment advice to give beyond reading Burton Malkiel’s book.  Generally, I believe in “efficient markets”***. In particular, if you have limited assets when you retire there are no miracle ways of accessing high-income returns. You need to learn to be frugal and budget to live within your means and can claim the aged pension.
*Malkiel is an enlightened believer in “efficient markets”. With a few exceptions, he does not believe in “stock picking” but prefers “no-load” mutual funds.  Malkiel is excellent on retirement planning where he favors a major proportion of investments being in REITs and fixed interest securities.
** One which includes direct debit of dividends or their reinvestment in dividend investment schemes.
*** Again following Malkiel I occasionally punt on investments about which “bubble-like” dreams can be built. But this is a risky business and I limit it to 1-3% of my portfolio.

8 comments to Advising investors not to believe in active investment strategies

  • I am and will always be Not Trampis

    I have always been amused that advisors and managed funds for that matter never give back money if they lose money over a period

  • Henry Haszler

    On the issue of gouging fees, my wife and I looked into SMS funds — we decided against — and in the process consulted (first visit free) the Greensborough office of a national firm of investment advisors/managers. From memory this mob base their portfolio recommendations around 10, or was it 20, stocks and are linked to a much larger operation relying on the latter’s expertise. As the spiel progressed I asked about the fees.

    The consultants went through what was a complete B/S exercise saying the fees all depended on the specifics. Fair enough but they should have been able to make a guess in relation to a balanced investment.If not they must be incompetent. Anyway the senior guy eventually sent his subordinate out to look it up and while we waited continued his spiel.

    Bottom line, the fee was eventually and seemingly reluctantly quoted as 1.6% of the portfolio value. That’s $16,000 pa on a notional portfolio worth $1 million. These guys must have Armani and Porsche and perhaps other expensive habits to feed.

    I haven’t read the books Harry cites but seriously if the pros working full time can’t beat the index, what chance a part time mug investor? We have stuck to good stocks and with the help of the CBA things have been OK.

    As an aside, I know the banks have a lousy reputation, especially the CBA. But my advice is “don’t get angry at the banks and their fees, just buy their shares”.

  • hc

    I agree with you Henry. The costs I cite in the post are at the lower end of what is charged. The sharpies take most of any gains and bear no risks.

    In the example you cite the advisors are thieves.

  • I am and will always be Not Trampis

    They are thieves and will always be thieves until they reimburse monies when the market tanks

  • fxh

    ha Homer – you old Commo.

    I had some acquaintances who were “Financial Advisors”.. What they knew about finance or markets could be written on a yellow post it note – and it was wrong. The lurk was/is the trailing commissions. Once you had someone hooked it was $5,000 – $10,000 a year per customer forever. Without any work. At all.

    All they did was refer people to a few packages offered by big players. For a hefty up front commission and a perennial trailing commission. Both couples I knew who had their own small business advising have since moved into bigger more expensive houses, kids in private schools, and more expensive cars and have semi retired. Why not. The $$ come in forever with no work. They weren’t nasty people in person, or even in general, in fact without knowing what they did I would say they were good people to be with, but ethically I couldn’t stand to be with them. I never see them now.

  • hc

    Some are nbot nice guys FXH. They swindle their clients. I have no factored this into the rough numbers I provide above.

  • Henry Haszler

    Ahhhhhhh. Oh what beautiful words these are: information, disclosure and transparency.

  • I am and will always be Not Trampis

    Commo not a bit of it. They get paid well when they best the market and reimburse when the market beats them.

    Still wearing those safari suits FXH