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Monday 12 March 2012

Saving money can be a false economy – why the UK hasn’t got it wrong when it comes to investing

Over the last few weeks I have been putting together model portfolios for our clients, without going in to too much detail we spend a lot of time building the portfolios to understand the funds, the volatility etc. We then back test them and eventually when we are happy we then go back to the clients. About 50% of the money we look after for clients is invested in the portfolios, for the others we have more bespoke offerings. 

This made me think, the first thing is something I have been saying for ages. The portfolios are effectively part of the end solution. A lot of what we do is understanding a client’s goals and then delivering on those. The goals are key because only when we know what they are can we look for the solution, and ultimately when investing decide whether a portfolio is right for the client. 

Secondly is cost, when we look at the direct market the key message is that doing it yourself is cheaper, and you can’t argue with this. But let’s say a mixed portfolio of funds, and perhaps some investment trusts costs you 1.5% p.a., it may be worth asking how much it would cost to build advice into the package. Now fees can be a direct percentage or they can be a monetary amount. But assuming it is a percentage I don’t think it is unrealistic to see the charges coming in anything between 1.65% and perhaps on the higher end 2.20%. 

Now this is important because when you consider the cost of advice is only between 0.15% and 0.70% more than going direct you then can start to ask about value. The messages say if you go direct your fund will grow a lot quicker because you are saving money. I am not arguing with that message because it’s true but it also works on the assumption that those people going direct know what they are doing and why they are doing it. I have no proof but I suspect very few people know what they are doing, perhaps less than 20%. 

Many investors rely on the direct operation to steer them towards funds and portfolios, they rely on papers to highlight investment opportunities and actually often these investors have no idea whether the investment is right for them. To give you an example a Saturday paper was recently highlighting investment via a direct operation directly into corporate bonds as a means of getting income. If you understand these then perhaps this is right but if you don’t and you see a return of 8% p.a. without knowing the risk then this is very dangerous (of course there are tax implications as well). This goes further when you see products like structured products being pushed as income products, again they can and in many cases do work but do the people buying them really understand the risk.

My point is this that in the UK when “pushing” the benefits of going direct we focus on saving money, and we steer people towards investments. The problem is that many people don’t know what they are doing and actually end up losing money. When the markets fall they pull out, when markets rise they come back in. The question is whether paying a little more might be worth it in the long run because you have an expert who will look to understand goals and look for solutions. One final point when you buy a house you normally get insurance to protect it, when investing is it not worth paying for that protection? 

Taking this point a step further I may sound as if I don’t like the direct market when actually I do, I have personal experience in this and actually I smile when people say they want to challenge the big player. If someone has the patience and money then their is one very easy way to challenge the big player, and this is education.

Education I believe is key to success. Education is not about promoting funds or investment opportunities. Education is about highlighting the need to understand about goals, about building a financial plan, about understanding attitude to risk and then finally building a plan to deliver this. Without giving this away it is not difficult to do, there are some excellent examples of how to build this and be successful. The point is that unless the direct market act with responsibility, to me they are effectively just sharks picking up vulnerable people with little care for them. If someone takes this seriously, is prepared to build slowly they can change the way people think. 

But direct is not the only problem, UK financial planners / advisers (whatever term you wish to use) need to do the same, using their websites to talk about planning what it means, about risk etc etc. 

And finally we need to understand that many people are financially illiterate and actually cannot even budget or understand the basic concept of saving and unless we tackle this, this is going to be  a massive time bomb. 

So in summary in the UK we have focused financial services about saving money but actually saving money can be a false economy if you have no idea what you are doing (you may think you do). Until someone develops a direct proposition that offers education as part of the package this message will continue leaving many disillusioned investors. We need to wake up, financial education is about making a difference and we need to learn from the success in other countries.

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