Just how inefficiently can someone invest money?
I've always been told to make columns meaningful. Talk about the sizzle not the sausage, talk about how fast the car goes, not how many piston things it has!
I have assessed how most people are currently investing via the calls from the column so this is pretty much a broad selection of how much we are all wasting.
So, to give you some perspective on how much your investments are costing you, I have considered this as a comparison of your working week. Stick with it, it's messy but good. If an investor worked all week, it's surely fair to ask for a full week's pay? 20% inefficiency is the equivalent of one day in the week. To work until Friday but be paid for Monday to Thursday would be daft?
So just how inefficiently priced are investments?
Tax first: Most investors I have seen have purchased an investment bond. An investment bond is taxed as it grows and pays tax at close to 20%. An ISA or a collection of collectives via unit trusts, and then using your annual capital gains allowance would save that 20%, yet most investors do not do this. 20% of a week is one day, so we are now at Thursday.
Those who invest in a bond or most of the expensive pensions, tend to be exposed to mirror funds. Mirror funds are expensive versions of the real thing i.e. the fund marketed to you, and most investors don’t realise they are buying the expensive version. The difference is a 12% disadvantage per year on the examples I have looked at. 12% is over half a day, so we are now back to midday Thursday.
Investment bonds also have heavy charges which are hidden. Commission (often at 7%) and a set up charge of circa 4% mean that an investor is walloped by over 2% per year over the first five years of the investment. A reasonable fee for designing a portfolio of investments would be around 3% and most quality independent financial advisers can buy unit trusts at creation price which is less than 0.4%. So the investor is paying circa 7.6% over five years that they shouldn’t. Over five years this equates to a saving of 1.52% per year.
If the average return on an investment is 8% per year (and I am being generous here) the investor is paying 19% more than they should. 19% of a week is nearly a day, so we are now at midday Wednesday.
And now to investment performance: If the investor uses a specialist investment adviser as opposed to a high street bank/financial adviser and that adviser manages the money slightly above average you might expect a better return. The UK all companies sector is a list of 306 investment funds that are heavily exposed to the UK stock market and is a reasonably big destination for most financial investors' funds.
In the UK all companies sector, 177 of the 309 companies have below average performance. An independent financial adviser worth their salt would expect to be able to pick the funds which should perform in the top quarter. Even if an investor managed to put their money in a straight forward tracker fund they would have been more than half way up the top quarter.
Let's say a specialist independent financial adviser managed to be only half way up the top quarter. Over five years the return would be 29.2%, which is a far cry from the average of 15.5% (1). Over five years that’s 3.1% per year difference, or alternatively the average is 55% worse than mid top quartile. 55% of a week is more than 2.5 days. 2.5 days takes you to a Monday morning with a piece of toast in your hand and an egg, a point you may not have wished to bypass.
And before we consider cracking an egg, if you managed to buy an investment in a guaranteed or structured product or even one that had a 'kick out option', you are well and truly back in the bedroom with a cup of tea with no tea in it.
Most investors, however, need not miss one hour of inefficient investing, let alone a full week – and I haven’t even begun to look at how pensions work.
Peter is offering one free hour's assessment of how your investments or pensions are taxed or charged.
Call Peter on 0845 230 9876, e-mail firstname.lastname@example.org or take a look at our website www.wwfp.net.
The value of shares and investments can go down as well as up
Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'