First Published at www.savethestudent.org
If you haven’t figured this out by now, let me share one of the most important things everybody should know:
The world is full of people who would sell you toe nail clippings and magic cat dung… if they could get away with it.
Unfortunately, the financial service industry breeds more of those opportunists than any other sales field. And they can skilfully disguise feline faeces to look (and smell) sweeter than a bouquet of spring flowers.
As a young investor, you can’t afford to put some of these products on your dinner plate—not if you eventually want to grow wealthy. I’m a high school personal finance teacher who built a million dollar investment portfolio by the time I was 38 years old.
I published a book called Millionaire Teacher, The Nine Rules of Wealth You Should Have Learned in School. It hit #1 on Amazon USA for personal finance books in November 2011, #1 in Canada in February 2012, and now I want to boil down the essential elements for a young UK audience.
If you just read this with scepticism, good! That’s what I want.
Be sceptical of nearly everything people tell you, when they’re giving financial advice. Find academic studies that might refute it. Only then will you be educated enough to make a financial decision. Don’t listen to a salesperson or financial advisor who refutes or supports certain advice. Find an academic study, something truly impartial.
For starters, if you’re going to invest, buy assets that appreciate over time.
Cars lose their value each year, so it’s best to spend small amounts on depreciating assets (like cars) and more on assets that increase in value. I’ve seen the advertisements for Forex trading, especially targeting young people with grand promises. But remember this: for every dollar that’s made, there’s a dollar that’s lost. Always.
Unlike stocks, bonds and real estate, currencies (as a group) don’t rise in value. When you trade a currency, there’s another person on the other end of that trade. Do you really want to gamble with them? The only sure winner is the investment bank that makes money on the commission spreads from the sale and purchase. These products are pushed for that reason. They create excitement (usually for the naive) and reap tremendous benefits for the large brokerages doing the transactions.
Investors are better off buying assets that appreciate over time—rather than wasting time and money trading currencies.
If two people trade a currency back and forth for twenty years, the winner will win by an equal proportion to the amount lost by the loser. The odds are, also, that the winner wouldn’t win by much, if they each played the game for twenty years.
If you and I traded a stock market tracking fund or a London flat back and forth for twenty years, we would both benefit from the rising value of the stock market (plus dividends) or the rising value of the flat. We’d likely be better off holding those assets, rather than trading them, but my point is this: the overall stock and bond markets increase in value over time, as do real estate prices.
Forex trading doesn’t offer that. It gives low odds of success (like a night at Blackpool) and you won’t find Warren Buffett, nor a college endowment fund manager, nor an economic Nobel prize winner suggesting Forex trading as a sensible investment method. It makes money for the house, but not for the players, as an aggregate.
What would Warren Buffett suggest?
Buffett isn’t a fan of the financial service industry. He often jokes about a fantasy he has, where a bunch of brokers get trapped on a deserted island with no escape. Many investors buy actively managed unit trusts, but the firms that create them have one goal: to make money for themselves.
So how do you increase your odds of investment success?
If you think that Warren Buffett and a slew of Economic Nobel Prize winners offer valuable advice (these guys aren’t selling products) then you’ll be keen to build a diversified, low cost portfolio of tracker funds.
In the U.S., these are called index funds.
They’re extremely low cost unit trusts that beat more than 90% of professional investors over twenty year study periods, after all fees, attrition, and taxes. Investment advisors and brokers hate these products, and they’ll usually do everything they can to deter you from buying them. Brokers, after all, make more money for themselves when selling you litter box products instead. Portfolios of actively managed unit trusts (and their hidden fees) are generally a bad deal for investors.
Allan S. Roth, adjunct professor at the University of Denver, ran a Monte Carlo simulation to determine the likelihood that an account of actively managed unit trusts would beat an account of index tracker funds. After all, a responsible portfolio would have more than one tracker fund within it: it would likely have at least a British stock market tracker fund, a bond market tracker fund, and an international stock market tracker fund.
Roth determined that, if you had five actively managed unit trusts over a 25 year period, your odds of beating a portfolio of index tracker funds would be just 3%.
If you had ten actively managed mutual funds over a 25 year period, your odds of beating a portfolio of index tracker funds would be just 1%.
You won’t find academically supported evidence to refute those findings. For the best odds of investment success, index tracker funds are the right choice. Investing is about putting the odds in your favour.
|Five Years||Ten Years||Twenty Five Years|
|One Active Fund||30%||23%||12%|
|Five Active Funds||18%||11%||3%|
|Ten Active Funds||9%||6%||1%|
But not all tracker funds are created equally.
Some of them can be pretty expensive. In Richard Branson’s autobiography, Losing My Virginity, he said that:
“After Virgin entered the financial services industry, I can immodestly say it was never to be the same again. We cut all commissions; we offered good value products; and we were practically trampled by investors in their rush to buy.”
The great funds that Branson touted were Virgin’s index tracker funds. But they’re too expensive. Branson’s intentions might have been good, but HSBC offers the same products at a fraction of the cost. And in the world of money, small costs add up.
Check out what a 1% difference can make over an investment lifetime:
- One thousand pounds compounding at 7 percent interest for 50 years= 29,457 pounds
- One thousand pounds compounding at 8 percent interest for 50 years= 46,901 pounds
If you’re twenty years old, you could realistically have money working for you until the day you die. Sure, you’ll be selling some of it to cover living costs as you retire, but you don’t want costs to anchor your money over a lifetime.
I think the most convenient UK tracker funds are offered through HSBC.
In a 2008 study titled “Mutual Fund Fees Around the World” (published by Oxford University Press) researchers Ajay Khorana, Henri Servaes and Peter Tufano found that UK’s stock market unit trusts cost investors an average of 2.28 percent a year, including sales costs and hidden expense fees.
A portfolio of HSBC’s tracker funds, in contrast, would cost you roughly 0.29 percent annually. Virgin’s tracker funds cost more than three times as much.
When it comes to unit trusts, the lower the fees, the better.
As the global unit trust research firm, Morningstar reveals, low costs are the only reliable predictor of future performance. Don’t fall for unit trusts with great historical returns. The odds of them repeating that performance aren’t great.
Create a diversified portfolio of low cost tracker funds, and you’ll beat more than 90 percent of investment professionals over your lifetime—without any work. Don’t forget that a portfolio is not a single tracker fund—it’s a diversified basket of them. This is the gem that most professionals will never be able to beat.
For further information on the topic, I recommend these books.
And don’t let anyone lure you into the litter box.