For the past three months, for the first time in over 15 years, I found myself with plenty of time in my hands. To keep my brain busy, I decided to take ownership of the family investments, which till then had been largely delegated to advisors. In this time, I understood how little I knew about investing and how easy it is to be misdirected and ultimately lose - or limit the potential to grow - your hard earned money. Speaking with some friends, many of whom are very smart and successful managers and entrepreneurs, I realised that I’m not alone in this struggle. That’s why I decided to jot down my experience, and more importantly my practical learnings, to help others avoiding my mistakes and put their money to work.
A disclaimer: I’m not an expert on investment, and essentially none of the ideas I’ll describe are original or breakthrough, quite the opposite. My main sources have been the amazing Ray Dalio’s book “Principles”, J.L. Collins’ “The Simple Path to Wealth” (both of which are highly recommended readings) and a plethora of blog posts, YouTube videos and podcasts. When relevant, I’ll quote these sources and link to the original articles, but I’ll try to provide very practical advice and tell the story from the perspective of my story and mistakes.
Let me give you a bit of background about me. I’m lucky to have a decently high-pay career in marketing, which has taken me and my family to different countries and allowed me to live without constant concerns for money. However, said career also demanded a huge amount of time and focus, which proved a great excuse for me to avoid the hassle of researching my way into investing.
Until two months ago, my investment structure looked like this:
- My personal account (30% of total worth): about 20% cash for day to day expenses, 80% invested in ONE company, Apple. Now, I bought Apple shares in 2010 when they were about 50$ which, paired to a favourable Dollar trend versus the Euro, means that this investment is netting +332% as of yesterday. How I got to decide on that investment and why I kept it when everybody was telling me to sell is a story for another time, but if I’m honest luck played the main role in this investment.
- Family account (70% of total worth): managed by a consultant from a large Italian bank, which structured an initial investment portfolio (mostly actively managed funds, more on that later) and regularly met with my father to agree tactical investments, such as the purchase of a specific stock that he deemed undervalued. Over about 3 years of active management, total value of the account was negative -1% excluding dividends, and slightly positive (+0.2%) including dividends.
It doesn’t take a genius to understand that despite good results in my personal account, this investment structure made no sense. But to truly understand why, I had to go much more in depth in the family account management. Which leads me to my first learning:
Rule 1. KEEP THE LEECHES AWAY FROM YOUR MONEY
If you can only remember one thing from this article, remember this: you worked hard for that cash, and there’s no better person than you to manage it. Financial advise is a 56 Billion dollars industry in the US alone, and it’s whole existence stands on the belief that investing is hard (WRONG), takes time and attention (WRONG), and that can pick this or that investment for you and outperform the market (WRONG). If such experts existed, they wouldn’t waste time talking to you. They’d be sipping a margarita on a private island. If you don’t trust me, there’s plenty of evidence that actively managed funds underperform the market, even before taking out the high fees (here’s a [Morningstar study from June 2015] as an example). What DOES exist is an army of people that will take your money, invest it in average - at best - assets, and charge you a percentage of your whole net worth, EVERY YEAR, for the privilege. You earned the money, you should invest it. The best part is that investing is much easier than it seems, doesn’t require much time or complex skill outside of basic understanding of math, spreadsheet and some internet literacy.
So how was the family account “actively” managed? Over time we amassed more than 70 different investment lines, a mix of life insurances, “premium” mutual funds and single stocks. Premium funds made up about 3/4 of the portfolio so, obviously, I asked what was premium about them. The answer was that the funds were actively managed and supposed to provide strong returns. After digging a bit more, I found out that the other premium element was that they costed anywhere between 1.5% and 2.75% yearly as management commission. That is a crazy high, though not uncommon, commission. Two orders of magnitude higher compared to “passive” funds or ETFs (Exchange Traded Funds, aimed at replicating the trend of a given benchmark such as the S&P500) and infinitely more than single stocks and bonds which have zero commissions outside of purchase costs. Pair this with the fact that active funds don’t generate any better returns, and you can start to see why I decided for a drastic review of the portfolio (and I found a new bank). Indeed, in my case - on an admittedly short period of time so take it with grain of salt - higher commissions where inversely correlated to returns (Correlation index -0.28), as you can see from the chart below:
Why? Well, the fact that the high cost funds are “taxed” every year by an average of 2.2% commission may have something to do with the poor return. The most maddening part, though, is that commissions are completely hidden from the reports and it’s incredibly tedious and time consuming to even get the data. How that is not illegal in 2018 is beyond me. The results overall are also particularly disappointing because the stock market has performed very strong in the same period (12 months ending April 2017), with many major markets we invested in, including NYSE, NASDAQ, FTSE MIB, growing double digit.
How They Screw You: The Magic of Compound Interest
You might think “it’s still just a 2% fee, it’s not ideal but it’s still a minor part of my money, can’t be so bad”… and that’s why most people still use advisors. The idea is that the investment world is complex and that you need somebody to guide you, and that a small fee cannot hurt. The investment game, however, is played on compound interest. Einstein famously said that “compound interest is the most powerful force in the Universe”. Actually, to the best of my internet research capabilities, it’s unclear if Einstein ever said that… so for simplicity I’ll give you the math. [At this link you’ll find a very simple spreadsheet] where I simulated two different 100$ investments, both with a 30 years time horizon, both with a estimate return of +4% per annum, but while one operates on a 2% yearly commission, the other one has only 0.2% costs (I’ll share in a future post how to achieve lower costs without the negatives, but - SPOILER ALERT - it will involve Vanguard funds or ETFs). After 30 years, the high cost investment is worth 177.6$, while the low cost one is worth 294.9$. In other words, by agreeing on this small 2% commission, you just forfeited over 60% of your potential returns, and quite possibly all of it when accounting for inflation. Where has the money gone?? You bet: in the advisors’ pockets, at 100% margin and zero risk. Good job. So now you know the reason why this industry is so rich and why you keep getting offers to invest. And it’s not just about leaving money on the table. Investing your money is risking it. Giving up return for your investment is folly because at least some of your investments may net negative returns, or disappear completely. It’s your money, you or somebody close to you earned it, you are taking all the risks. Don’t let others steal your returns.
So what did I do? I closed ALL the “premium” funds I could and moved the money to a low cost operator where I manage my own investments (if you live in Italy, I’m partial to [Fineco Bank]). In a future post I’ll explain how you can use the rules of the game to your advantage and create a mostly automated portfolio to protect and grow your assets. Complexity is the enemy here (and unsurprisingly the main card that advisors use to confuse you), and we can easily build “set and forget” portfolios or more fun (and risky) ones to keep you entertained.