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If a Nobel Prize for Defending the Interests of Poor Private Investors were inaugurated, I would nominate John Bogle, the legendary American investor and founder of Vanguard fund management.
One of Bogle’s beefs is with the high costs imposed on private investors by fund managers – in most cases, for adding no value at all.
At the 60th Anniversary Conference of the Financial Analysts Journal in February 2005, he blasted the US investment industry with the following observations:
● The revenues of investment bankers and brokers came to an estimated $220bn
● Direct mutual fund costs came to about $70bn
● Hedge fund fees came to about $25bn
● Fees paid to personal financial advisers amounted to another $5bn.
The grand total was approximately $320bn – “all directly deducted from the returns that the financial markets generated for investors before those croupiers’ costs were deducted”. Only 20 years earlier, the same costs totalled a “mere” $50bn.
The real problem, according to Bogle, was that these escalating costs don’t even deliver the goods, compared with a bog-standard, cheap tracker fund (provided by the likes of Vanguard, his firm).
“Let’s look at the record,” Bogle said. “Over the past 20 years, a simple, low-cost, no-load stock market index fund delivered an annual return of 12.8 per cent – just a hair short of the 13 per cent return of the market itself. During the same period, the average equity mutual fund delivered a return of just 10 per cent – a shortfall to the index fund of 2.8 percentage points per year, and less than 80 per cent of the market’s return. Compounded over that period, each $1 invested in the index fund grew by $10.12 – the magic of compounding returns – while each $1 in the average fund grew by just $5.73, not 80 per cent of the market’s return, but a shrivelled-up 57 per cent – a victim of the tyranny of compounding costs. And that’s before taxes.”
I’ve quoted extensively from Bogle because I believe the UK suffers disproportionately from this long-term “tax” on returns. Luckily, change is afoot. Some product providers are trying to make life easier and cheaper for private investors.
One innovation of which I’m a huge fan is something called the regular investment plan – TD Waterhouse, Selftrade, The Share Centre and Halifax Sharebuilder all offer schemes that allow you to buy shares on a once a month, bulk-buy basis for between £1 and £1.50 per purchase including VAT.
The reason I’m so excited about these cheap dealing accounts is that you can use them to buy even cheaper exchange traded funds (ETFs) that track indices. ETFs directly address Bogle’s point about cost: the average total expense ratio for an ETF is between 0.4 and 0.7 per cent, compared with an average of 1.65 per cent for an actively-managed unit trust, bought via the “wrap” platforms used by independent financial advisers (IFAs). A difference of 1 per cent a year may not seem a great deal but, over the long term, the effect on returns can be huge.
I’ve developed a spreadsheet that compares the costs of ETFs bought through a regular investment plan versus a wrap-derived unit trust. It demonstrates the astonishing fact that, even if the bid-offer spread on an ETF was a monumental 2 per cent, and you only invested £50 a month – paying £1.50 dealing costs – the ETFs would still save you money over the years.
Fund managers will claim that they add value by delivering above-average returns. But I’d suggest this is untrue and clouds the issue: the putative promise of future extra returns shouldn’t blind you to the hard reality of extra costs now.
So, in my opinion, the stockbrokers who provide these regular savings plans deserve a big pat on the back. However, there is a sting in the tail: the number of ETFs you can buy through these schemes is limited. I have an individual savings account with TD Waterhouse, which claims to offer a wide range of ETFs. In reality, it has fewer than 100 of the 500 listed in London, although good coverage of iShares ETFs. Selftrade offers fewer than 50. The Share Centre offers 142, and charges just £1 per trade but its Isa fees are a tad expensive. Halifax Sharebuilder does the best with 190 ETFs on offer.
Nevertheless, these regular investment plans are a godsend to investors – they just need to include more ETFs!
These brokers will only do this if they understand the demand for ETFs. So they need to hear from you. I’ve listed the e-mail addresses for each of the brokers below. Why not tell them the top five ETFs you’d like to see included in their regular investment plans.
I’m pretty certain that these guys will increase their coverage – and that the ETF providers will help to improve liquidity. I’ll report back on progress in a month’s time. Over to you!
The Share Centre: email@example.com, Halifax: firstname.lastname@example.org, Selftrade: WhatETF@selftrade.co.uk, TD Waterhouse: email@example.com
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