Dobson Hodge No Comments

‘Unknown Unknowns’ … part 1

Donald Rumsfeld once outlined the nature of knowledge and the danger of not knowing what you don’t know (http://goo.gl/4vWDQ). His infamous ‘known knowns, known unknowns and unknown unknowns’ description resulted in some derision – notably the Plain English Campaign gave Rumsfeld its Foot in Mouth Award in 2003 (http://goo.gl/YEzDrQ).

However, he also received some support given that he made something quite complicated fairly straightforward as it focuses our minds on the fact (and potential danger) of not knowing what we don’t know.

Financial planning can be full of unknown unknowns and therefore there are dangers which many could be oblivious to. Some dangers may simply simply be down to a lack of awareness – others due to misinformation.

A good example is the FTSE 100 – the leading index used (for some reason!) to provide a measure of UK investments. (The fact that only a very small minority of people will solely invest in the FTSE results in this being a dangerous barometer for investment returns but that’s an altogether different debate).

The FTSE100 index does not factor in dividends – a crucial part of equity investment returns. Using the FTSE 100 as a measure of investment performance is like putting your money in the bank, ignoring the interest and then asking why your money hasn’t gained in value.

Some equity indices (e.g. the Dow Jones) do include dividends and therefore comparisons between the Dow index and the FTSE is like comparing apples and pears (something I’ve warned about here).

On 30th December 1999 the FTSE stood at 6930. On 28th November 2014 it stood at 6729. Almost 15 years on it therefore stands some 200 points lower.

Over the same period, the Dow Jones Industrial Average stood at 7133 and now stands at 11288 – some 4000 points higher.

Seemingly the FTSE 100 has therefore significantly lagged behind the Dow – however that is until dividends are factored in.

Once dividends are factored in, the FTSE 100 has actually delivered a gross total return of 61.5% over the period (whereas the Dow stands at 60.2%).

FTSE

Investors therefore need to be mindful when reading articles about the Dow hitting ‘record highs’ when, from a capital return point of view, it’s actually lagging the FTSE – which, to date, has not yet returned to the heady heights of the Millennium!

In this media savvy, ‘here and now’ culture, sound bites can imply one thing when the reality is very different and it’s for this reason Mr Rumsfeld’s words provide a useful warning that things are not always as they seem – 2nd December 2014.

Dobson Hodge No Comments

The price of everything and the value of nothing…

Many independent financial advisers will spend a great deal of time analysing financial plans and, invariably, the costs involved in the clients strategy.

Currently, there is much political and media focus on costs (‘rip off Britain’?) yet in the next breath there are also complaints wages aren’t rising fast enough (a cost in other words) and companies are too reliant on zero hours contracts (a means to control a variable cost). In other words, it feels like the aim is some utopian world where everyone is paid well but everything is cheap; and whilst this is perhaps a simple analogy, similar arguments are being made when it comes to pensions.

There has been much improvement in the transparency of costs over the recent years; firstly with the cost of advice being stripped out of the cost of the contract (though in some cases ‘integrated’ advice firms still bundle advice costs within their contract costs).

Since then, the cost of the investments themselves have also become ‘unbundled’ whereby the cost of the investment, the cost of advice and also the cost of holding that investment have all been separated – however in some cases, the result of this transparency is an increase in cost.

In the vast majority of cases, transparency is positive for the consumer – it’s a prerequisite of any trusted market – but care needs to be taken where transparency results in rising costs and a lack of consumer understanding.

There was coverage over the weekend of Ed Millibands warning of the costs of pensions once the new flexible rules are introduced (http://goo.gl/tsDDVt) and how consumers must ensure they are ‘not ripped off’ by financial firms.

This is interesting given that regulated financial advisers operate in one of the most tightly regulated professions in the UK – and yet there is still the focus on costs and these costs being ‘rip offs’. A further article this weekend in the Independent about “confusing and unfair (investment) charges” – (Simon Read, the Independent) further focussed on investment costs.

In a Twitter exchange, Mr Read was asked why he felt investment charges were unfair – (http://bit.ly/1Cr6I7U) – to which he responded that they were unnecessarily high. Whilst it was agreed that some funds were indeed relatively expensive, there are cheaper options – and even so, just because the cost is higher it doesn’t make them ‘unfair’ and Mr Read was therefore challenged on specifically what he felt was unfair – and to date no reply has been received.

And therein is the key point – costs are costs and, generally, something is worth what someone is willing to pay for it.

Not all fund managers disclose the full costs of their portfolios (though some are beginning to do so) and you can invest in funds with charges ranging from perhaps 0.1% per annum up to 3%+ – all working in different ways and, no doubt, all can justify their fees.

Is a fund charging 3%+ ‘unfair? – perhaps only if the consumer is being duped into paying it. If the investor chooses to pay it then everyone should be happy – after all, we don’t pay £10,000 for a new car and expect to drive off in a Lamborghini and whilst we may feel that a Lamborghini is expensive, there’s a difference between that and it being ‘unfair’ or a ‘rip off’.

A bug bear when considering charges is that the vast majority of us have savings accounts and we can identify the interest rate we’re earning; however ask the bank about the charges of them managing our savings and it is likely you will receive a quizzical look. So if 0.75% interest is earned on a savings account yet the same bank lends to mortgage borrowers at 4% (noting that borrowers will typically have set up fees too), can it be presume that the cost of the savings account is 3.25% per annum? Again, this is simplistic but the depositor is essentially lending the Bank cash in exchange for 0.75% and they in turn do the same yet receive 4%.

Is this unfair? Is this a rip off? Probably not – it’s market forces – however the key point is that the regulated investment environment has cost disclosure everywhere yet this doesn’t apply to the deposit accounts for which we are oblivious to the cost.

Whilst transparency of funds could improve by the entire cost of the fund management being identified, this could result in a conflict of interest between the fund manager and his clients (i.e. the fund manager may become mindful of significant dealings reflecting badly on his charges figure OR if the fund manger works to a fixed cost, any excessive dealing costs would fall on him even though the actions are for the benefit of the client). Furthermore, in the former example, such a charging figure will be retrospective and therefore is indicative.

Surely the biggest issue facing consumers is not whether their annual charge is 0.5% or 1% but whether they are aware of the big picture – will their funds run out before they die, are they receiving regulated advice or are they being ‘sold to’, is the advice even regulated and, ultimately, are they being promised the earth and they are about to stumble into something which could leave them with massive tax bills and penalties from the Revenue.

Our genuine concern and fear is that articles warning of ‘rip off’ pensions only succeed in making consumers focus on cost rather than value and totally miss the big picture.

If an investor seeks independent regulated advice and explains that costs are a concern and they want to invest in as cost effective way as possible then this objective can be achieved with no conflict of interest or bias and therefore perhaps the mainstream media furore should be more focussed on the dangers of people being ‘ripped off’ by non-advisers ‘selling’ unregulated investments than whether a fund should cost fractions of a percent less – edited 29/11/14