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This is an audio transcript of the Money Clinic podcast episode — Investment Masterclass: the cheapest way to invest

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Claer Barrett
When it comes to investment advice, many turn to legendary investor Warren Buffett. After all, with tens of billions to his name, he’s not called the Sage of Omaha for nothing. Earlier this year, he said, Don’t waste money on investment advisers. He would rather have monkeys throwing darts to pick his stocks and investments.

Warren Buffett
Take away the management fees and everything. I’m oh, I’ll bet on the monkeys, but not I don’t consider them a superior species and I don’t want them to move next door instead of my next-door neighbour. But that is the way. It’s just the way it has to be.

Claer Barrett
What Buffett was suggesting there is that it’s virtually impossible to outsmart the market and it’s expensive to pay somebody to try to do so for you. But what you might ask, if you don’t have any monkeys to hand, is the alternative. Well, coming up, an investment masterclass in something known as passive investing and why passive could be a better bet than active.

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Welcome to Money Clinic, the weekly podcast from the Financial Times about personal finance and investment. I’m Claer Barrett, the FT’s consumer editor.

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Now, if you don’t have a Scooby-Doo what I’m talking about with passive versus active investing, then don’t worry, there’ll be some jargon busting shortly. But it has been a bumpy old ride for investors in recent months as politicians enact one U-turn after another. Anyone apart from a lettuce would know this. So I wouldn’t blame you for thinking I’m not gonna touch investing with a bargepole right now. However, hear me out. This week’s episode offers an investment approach that is all about playing the long game. My guests today are the authors of a new book about what they describe as evidence-based investing. It’s called How to Fund the Life You Want. Well, everyone needs to know about savings, pensions and investments, and it’s just been published. And a quick disclaimer before we get started. The views discussed on this podcast about investing are just that people’s opinions. You also need to do your own research. Money Clinic is not intended as financial advice, as regular listeners will know. Now, on with the show.

I’m joined by Robin Powell and Jonathan Hollow. Welcome to the studio.

Robin Powell
Hello there.

Jonathan Hollow
Hello, Claer.

Claer Barrett
Can you introduce yourselves to our listeners?

Robin Powell
So, I’m Robin Powell. Ahh, Claer, I’m a journalist like you. I have a blog called The Evidence-Based Investor. The strapline “No sales agenda. No marketing spin. Just the evidence” tells you really all you need to know about it. And if this doesn’t sound too pompous, I’m also a campaigner for a fairer, more transparent investing industry.

Jonathan Hollow
And I’m Jonathan Hollow. I most recently worked for the government’s Money and Pensions Service, helping to develop a financial wellbeing strategy for the UK. And I also worked with people from other countries in an OECD network looking at how best practice is done for financial literacy across the world.

Claer Barrett
Now, your forthcoming book is called How to Fund the Life You Want. So I thought we’d start by talking about what inspired you both to write it. Now, Robin, you say in your foreword, “Had I known what I now know about investing when I was 21, I probably would have retired some years ago.” Tell us about that.

Robin Powell
Well, yeah. I mean, the sooner you start investing, the better. And the more you can put away in the early years of investing, the better. That was clear, and ahh Claer, I got that bit right (laughs). I did start early. I did invest a fair chunk of my income. But unfortunately, I made all the classic mistakes that young investors tend to make. In particular, for example, I chase performance. You know, I was looking for the bright, shiny objects, if you like. And I just paid far too little attention to fees and charges, which, you know, it was only many years later I realised that actually are really crucial to good investor outcomes.

Claer Barrett
And Jonathan, your big beef is that dealing with your finances is, is hard enough without the burden of complexity and confusion, as you call it, which can often be added by our financial services industry. Tell us more about that.

Jonathan Hollow
Well, I suppose my work at the Money and Pensions Service, I came into contact with a lot of evidence about the consumer problems and the consumer barriers that people face that stop them from doing something about investing, retirement and pensions. And I think the paradox for me is the basic principles of how to invest are very simple, but there are lots of things that get in the way. And I think some of the main things are the rules, the complexity of the rules, the kind of layers of regulations. There’s the asymmetry between the financial services firms and what they know about their products and what consumers know and want to know about the products. I mean, a lot of consumers are either bored by financial services products or scared of them.

Claer Barrett
Mm-hmm.

Jonathan Hollow
And so, some firms can really exploit that difference. And then the other big area of barrier is our own behaviours, our own emotions, which get in the way of doing what we know we need to do. So, I thought it was a very inspiring project to work with Robin on a book that demystified this and took real account of the emotional dimension rather than pretending that people are rational robots.

Claer Barrett
So, Jonathan, for the benefit of somebody who doesn’t know, listening to this podcast, how would you describe the difference between an actively managed fund and an index fund?

Jonathan Hollow
So I would say an actively managed fund is a handpicked fund where investment managers use lots of research to try and work out what they think are the winners, and they select a relatively small number of winners to put in their boutique fund. An index fund is trying to represent the, the exact companies that are in an entire market. So say, all small businesses based in Europe or all large businesses in the United States. And an index fund is taking a slice of every single one of those businesses in relation to its size and representation in the market. So an index fund is just a miniature representation of a market.

Claer Barrett
Excellent. That’s a really, really clear way of getting people to think about it. Now, buying individual stocks is, by its very nature, a high-risk approach to investing. But by contrast, Robin, you’re a very famous advocate of passive investing. Could you explain to those who don’t know why it’s the approach that you favour as an investor yourself?

Robin Powell
Yes. So I advocate long-term buy-and-hold index investing. I tend not to use the term passive investing for, for various reasons, but the terms are essentially interchangeable.

Claer Barrett
Mm-hmm.

Robin Powell
Now, an active investor will try to beat the market in one of two ways: through stock picking or from market timing, or indeed a combination of those. And an indexer, by contrast, will actually just simply invest in the whole market. And there’s a welter of evidence going back to the 1950s that shows that indexing is superior to active investing. And we refer to some of it in the book. And but it’s essentially down to simple arithmetic. So, we all want to be better than average. You know, we all think that we are better than average or most of us think we are better than average. But statistically, half of us can’t be. And whether that’s driving or picking stocks or whatever else, half of us have to be below average. And the data shows that sooner or later, all funds will actually revert to the mean, if you like. And the big difference between active investing and indexing is that one is far more expensive, I mean, far more expensive than the other. So once you factor in fees and charges, the average index investor has to — and there are no ifs or buts about it — they have to outperform the average active investor. Just one final factor to squeeze in. And the evidence shows that around 1 per cent of funds outperform in the long run on a properly cost-and-risk adjusted basis. And, you know, your chances of identifying those very, very few winners in advance are absolutely minuscule.

Claer Barrett
Mm-hmm. And of course, the difference in fees is also pretty astronomical.

Robin Powell
Well, that’s right. I, hmm, we’re not talking about a difference of 1 or 2 per cent here. We’re talking about index investing being somewhere between five and ten times cheaper sometimes. And you shouldn’t just look at the annual management charge, because really that’s just part of the picture. We have something in the UK called the total expense ratio and honestly Claer, only in the financial services industry could you have something called the total expense ratio which doesn’t actually give you the total expense.

Claer Barrett
Bah!

Robin Powell
Mmm, because a critical cost is the cost of trading.

Claer Barrett
Yes.

Robin Powell
And the beauty of index funds is — particularly market cap weighted index funds, which are most of them — is that they trade very infrequently. So you keep your costs, your transaction costs to a minimum. Active funds, because they’re active, tend to trade quite a lot. And actually, the evidence shows that active managers do turn over their entire portfolio remarkably frequently. And every time they trade, there’s a cost to you, the customer, and there’s a line of people, intermediaries. You wouldn’t believe the number of intermediaries that are actually involved in this whole process. And these costs all add up. And so your, your costs can, in some cases amount to, you know, the same as the annual management charge. So in some cases, you can actually double the annual management charge to reach something like your total expense.

Claer Barrett
Now before we get on to the meaty filling of this investment masterclass, I want to make it completely clear that neither Robin nor Jonathan nor I, for that matter, are financial advisers or investment professionals. The ideas we’re discussing here are for information and educational purposes only and are not intended as an investment recommendation or individual financial advice.

Now, Robin and Jonathan, the big lessons in your book about financial literacy can be distilled down to six themes or rules that crop up again and again. Now we’re going to devote a few minutes to discussing each of these concepts and why you believe they’re the key to investment success.

Starting with Rule No 1: Have a purpose, plan and method. Jonathan, let’s unpack what you mean by this. Why is the bigger picture so important when it comes to investing?

Jonathan Hollow
Well, firstly, the book is really not just about money. It’s about life. When you’re thinking about your future life. And if you want to be motivated to save and invest for a future life, you have to know what’s gonna give you happiness in that life. So, you’ve got to have a purpose. And then the other thing is you’ve got to have a financial plan. You’ve got to know how much money you will need to last you over your future life and have an idea of how you’re going to invest your way towards it and save your way towards it. And then when we talk about method, we talk about everyday money management — squeezing the most out of your pay cheque, squeezing the most out of your employer contributions and everything that can contribute both to a happy day-to-day money life and your future investments. You know, life is a great canvas, but the big mistake would be to say money is the goal. Life is the goal, and money is the means.

Claer Barrett
Rule No 2: Take a slice of everyone’s business. Now, Robin, I love this quote from your book: “The investment industry rarely promotes index funds because it makes far more money out of selling us actively managed ones.” Tell us a little bit about this rule.

Robin Powell
Well, as you rightly said earlier, buying individual stocks is very, very risky. So, and if you’ll allow me, I would like to give your listeners a stock tip.

Claer Barrett
Go ahead.

Robin Powell
(Laughs) And my stock tip — and you have to keep this under your hat — is, is called Global Capitalism, Inc. And you can buy a bit of Global Capitalism, Inc if you buy a low-cost global equity index tracker. When you invest in a, in an index tracker or a globally diversified portfolio of index funds, what you’re doing is you’re buying a stake in human enterprise. You know, you’re buying into the best businesses all around the world that the planet has to offer.  Now, and as you say, the investing industry, they don’t want us to buy index funds. Why not? Because it’s an existential threat to the active fund industry. And frankly, all those advisers, investment consultants and other assorted charlatans who claim the ability to be able to spot the winners in advance. All the evidence suggests that it’s not possible. And yet, we constantly reading people in the, in the in the papers, seeing them on CNBC and so on, trying to suggest that they know which the sectors, which the stocks, which the funds are, the winning funds of the future are going to be. Mmm, resist that temptation. You know, instead of looking for the needle, if you like, just buy the whole haystack.

Claer Barrett
(Laughs) Looking for the needle. Buy the whole haystack. Fantastic. OK, let’s move on to Rule No 3: To dilute your risks, add lots of time. Jonathan, talk us through this one.

Jonathan Hollow
Well, this is really about the long-term evidence that we present in the book. So we present evidence of how different classes of shares have performed over decades or in some cases, 100-120 years. And you can see that over very long periods of time, for example, shares in very small companies have quite high levels of growth. Shares in larger businesses have steady levels of growth, but lower and so on and so forth. But if you went out and bought an index fund in small company shares now and expected to make a lot of money of it, out of it in the next year, you can’t bet on it. It would be a rollercoaster ride. It might go down by 20 or 30 per cent in a year. So, the point is that time smooths out these risks. And the longer you hold shares for, the more likely you are to get this average result that the evidence shows from the past. Now, the past isn’t a guarantee of what will happen in the future, but we do think that paying attention to the very long-term evidence is the best guide we have to investing and diluting risk.

Claer Barrett
OK. Now, Rule No 4 is: Only focus on what you can control. Now, at the moment, Robin, that’s pretty personal for investors.

Robin Powell
Absolutely. I mean, one of the really interesting fields in, in finance, in academic finance in the last sort of ten or 20 years or so has been the growth of behavioural finance. And behavioural finance experts have shown a number of biases, if you like, which stop us making rational decisions. And one of these is the illusion of control, you know. Think about the things we can’t control. We can’t control markets. We can’t control fund performance. We can’t do anything about the current inflation scare.

Claer Barrett
Yeah.

Robin Powell
Mmm, what can you do? Well, you can control your costs. And that’s a really, really critical thing to do. You can control your asset allocation. And again, all the evidence suggests that is a hugely important contributor to investment outcomes. And it’s not easy, but you can actually, if you’re disciplined, self-disciplined, you can also control your behaviour. So focus on what you can control. Forget about the rest.

Claer Barrett
OK. Now, the next rule is especially applicable to investors today with the rising cost of living and volatile markets. Because, let’s face it, the financial challenges of the present time are making it more challenging to save and put money aside for the future. Many young listeners may be looking, for example, Jonathan, at their pension contributions and thinking, “Is that something I could cut back?” So Rule No 5 is: Phone a friend, especially when times are taxing.

Jonathan Hollow
Yes, we wrapped a lot up in this rule. I mean, it links to what Robin was just saying about managing your own behaviours and your emotions. In this country we don’t talk enough about money. Friends are a great source of solace when you know markets are plunging and you need to hold your nerve. We don’t, absolutely don’t want people to say, “Oh, listen to your friend who bought this one great stock, you know, and made a pocket on it and then invest in that.” So don’t go to your friends for investment advice. Go to them for emotional support and general understanding. You know, talk to your friends about how much money they think they need to set aside for their retirement. A lot of these things are kind of dirty secrets. But the other aspect of it is we do think there’s a really important role for good, regulated financial advice. And a good financial adviser should be like a friend. They should be able to give you really good help with tax rules. We think that’s a really big benefit of going to financial advisers if they’ve got the right training in tax advice. So we’re saying: seek a wide range of opinions, both professional and personal. Seek emotional support. Make money less of a dirty secret. But don’t go to your friends for investment advice.

Claer Barrett
And then a final rule. Rule No 6: Keep your investments cheap, simple and automated. The kind of rule I like, I have to say.

Robin Powell
Yeah. I think this advice sums it up really. Isn’t it cheap? We’ve talked about this a little bit. You know, cost is the single-biggest predictor of future returns. Simple. Keep your investing simple.

Claer Barrett
Mmm.

Robin Powell
Now, investing isn’t easy, you know, for the various behavioural issues, reasons we’ve, we’ve already discussed. But it’s simple you know, and it should be simple. The rules, successful investing are simple. So why do we make it so complicated? The reason we make it complicated is so we can pay all the intermediaries for their, for their expertise. But keep it simple. And finally, automated. Mmm-hmm, I mentioned that human beings aren’t very good at making rational decisions. The fewer decisions you make as an investor, the better. Automate it so that way you don’t even have to think about investing. And it’s hardest to invest when markets are falling and everyone’s scared about inflation in the economy, and the economy and so on. But if you just automatically put away £50, £100, whatever it is every month, and you don’t even think about it, that’s the way to invest.

Claer Barrett
And Jonathan, with the automation front, obviously listeners in the UK can use stocks and shares ISAs, but they can also use their company pension. And I have a combination of the two. I make a regular monthly investment into my ISA. That’s all set up, go straight into a bunch of different index funds, and I make a regular monthly contribution into my company pension. I get match funding from the FT. Thank you, FT.  And I also get tax relief. Thank you, Government. And all of these things in concert will hopefully get me closer towards retiring before I reach the age of 70.

Jonathan Hollow
Absolutely. And I suppose, you know, what we said in the book is just, you know, everybody should know that they’re squeezing the maximum they possibly can out of their employer contribution because some employers will make a higher contribution as you raise yours. So that’s one aspect of automation that is, is very important and powerful.

Claer Barrett
So finally, Robin and Jonathan, I’m going to ask both of you. If investor listeners do one thing as a result of hearing this podcast — What should it be? Other than buying your book, of course.

Jonathan Hollow
Well, I would start with reviewing your fees. We’ve talked a lot about that being a key thing you can control. During the course of writing the book, I thought I was doing pretty well on my own fees, but I got them down to 0.28 per cent, so just above a quarter of 1 per cent. Many people will be paying ten times as much. And as Robin says, they won’t necessarily be getting anything more for that. And indeed, with the worse performance of active management, they may be getting less.

Robin Powell
I’m sad to say this, Claer, but be suspicious. You know, everyone is trying to sell you something. You know, the investing industry is a... is a large skimming operation. (Laughs) You know, they just want to have a little bit of your wealth. And, you know, it might be that it’s worth paying it, but in many cases, it won’t be. But just be aware of what they’re trying to sell you. If I could just say one very final thing. You mentioned the FT paying the max contribution. That is such a good idea to, to maximise the amount that you’re paying into your pension. And if you’re not paying the maximum and you’re not getting the maximum matched contribution from your employer, it is like turning down a pay rise, which is absolutely bonkers. Obviously, something I’ve gone on about to my 21-year-old son, who’s litigious a couple of weeks ago, started his first job. And if he’s listening: Ollie, you know, make sure you pay the maximum contribution and get your employer to match it.

Claer Barrett
And it will cost you less than you think because that contribution is going in free of tax, in many cases freeing up insurance as well. And it will potentially bring down the amount of your salary that the student loan repayment is charged on to.

Robin Powell
Absolutely right. You wouldn’t turn down a pay rise, so why turn down an offer like that?

Claer Barrett
Both, thank you so much for coming into the studio today to discuss these really important money themes with us. It’s been hugely enjoyable to meet you properly in person and to hear all of your ideas.

Robin Powell
Likewise, Claer. Thank you very much for having us.

Jonathan Hollow
Thank you, Claer.

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Claer Barrett
Well, that’s it for Money Clinic this week, and we hope you like what you’ve heard. If you do, leave us a review. And if you would like to chat with me on a future episode of the show, then get in touch. Our email address is money@ft.com or send me a DM on social media. I’m @ClaerB.

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Money Clinic was produced by Persis Love and Philippa Goodrich. Our executive producer is Manuela Saragosa. Our sound engineer is Breen Turner. And the original music is by Metaphor Music. And finally, as I said earlier, the Money Clinic podcast is a general discussion around financial topics and does not constitute an investment recommendation or individual financial advice. For that, you’ll need to find an independent financial adviser, but follow Jonathan and Robin’s tips when you do. That’s the small print over and done with. See you back here soon. Goodbye.

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