Statistical uncertainties. A topic which the non-mathematician in me found rather daunting. As someone who prefers to do my own retirement planning and investment management, the reality is that I have to deal with a wide range of uncertainties on a daily basis. Getting away from that fact is not possible so I need to have at least some understanding of the basics.
Sam Savage's "The Flaw of Averages" was exactly what I needed to get my mind around some of the key issues. Written in terms that even a layperson can easily understand (and with plenty of humour), this book made for an educational and entertaining read.
Some key takeaways:
1. replacing uncertain future outcomes with a single average and then relying on that single average to plan for the future is a systemic error which explains why forecasts are always wrong (this is known as the "flaw of averages";
2. there is an important distinction between "risk" and "uncertainty" (uncertainty being an objective feature of the universe while risk is a more personal construct;
3. techniques for reducing uncertainty;
4. average inputs do not always deal produce average results;
5. the Seven Deadly Sins of Averaging (actually 12 of them);
6. some practical examples from the world of personal finance. Of these the most important is that a retirement portfolio which is adequate if a single average rate of return is achieved over the life of the portfolio is as likely to fail as to succeed.
Highly recommended for anyone with an interest in personal finance or investment management.
Saturday, November 20, 2010
Friday, November 19, 2010
Why you don't need an adviser
In my previous post, I had a mini-rant against financial advisers who charge high fees without offering any value added services. My view is that you do not need to pay for a financial adviser if you are willing to do a small amount of homework, do a small amount of work and accept responsibility for your decisions.
Financial advisers cost money. Most charge either a percentage of assets under management or get a commission from anything you invest on or both. There are usually a few other costs thrown in. So what do they offer in exchange for these services? The list may include:
1. basic investment advice: for the most part you don't need this. Even if you want to spend as little time as possible on your investments, reading a few books like The Boogleheads Guide to Investing will be enough to tell you to (i) keep the costs low (ii) go with an equity/bond/cash allocation that suits your age profile, risk tolerance etc. (iii) avoid chasing performance and so on. You don't need an adviser to tell you to do this
2. selecting investments that will outperform: most advisers fail to beat an appropriate benchmark before fees. Even fewer do it after their fees. Past out performance is not a basis for determining future performance. Predicting which advisers will "outperform" is a guessing game with the odds firmly stacked against you. If you want to try and do better than a basic investment investment plan (see #1 above), you need to accept (i) that more work will be involved (ii) the odds are stacked against you (iii) you have a better chance of outperforming if you aren't handicapped by the adviser's fees
3. access to investment products: in the bad old days, there were no ETFs listed in HK, there were no low cost index funds available to the public and it was an exercise in futility trying to access products like Vanguard. Your options were largely (i) buy shares directly or (ii) pay a hefty front end load and a hefty management fee to buy into actively managed funds. Front end loads of up to 5.75% and MERs in excess of 3% pa were not uncommon. And people wondered why the fund penetration rate in Hong Kong was so low. That started to change in November 1999 with the listing of the HK Tracker fund - the first ETF to be listed in Hong Kong. Now there is a wide range of ETFs listed on the HKSE. You pay no front end load on these (only brokerage and other transaction costs which are quite low) and while the typical MER is higher than Vanguard it is still only a fraction of what you would pay for an actively managed fund. It is also easy enough to buy ETFs listed on overseas exchanges if there is something you want but can't find locally. You don't need an adviser to access these - only a broker and a willingness to read the offering document and watch the bid ask spread before you buy
4. domestic tax planning: if your only place of domicile is Hong Kong, you don't need tax advice to make your investments. Hong Kong's tax laws are that simple. Unless you are investing as part of a business, you do not pay taxes on capital gains, you do not pay taxes on dividends and you do not pay tax on interest. There is no estate duty under Hong Kong law. Stamp duties and a few other levies are payable on some investments, but unless you are dealing with very large transactions these cannot be avoided. I see no scope for a financial adviser to add any value here
5. international tax planning: if you are tax resident in another jurisdiction, have assets in another jurisdiction or are a citizen of another jurisdiction, you will probably need to have at least a basic understanding of the tax implications. For most countries the three main issues which need to be considered are (i) withholding taxes on income (ii) application of estate taxes and (iii) liability to pay income taxes. The first two can usually be found with relatively little effort using the Internet. The latter issue will usually require more work and may require the assistance of a professional tax adviser. As a general proposition, if the tax situation is sufficiently complicated that you need an adviser then you need a tax adviser and it would be risky to rely on a financial adviser
6. estate planning: there is no estate duty in Hong Kong. Assets held overseas may or may not be caught in an overseas estate tax regime. There are some legal restrictions on who you can and cannot leave your money to. Depending on circumstances, you may want or need to set up a trust (e.g. to benefit infant children). Advice on these areas is best given by a lawyer (not a financial adviser)
7. insurance: work out how much you need and shop around for the best deal. This applies to term life insurance, medical insurance and home and contents insurance. You don't need a financial adviser to do this for you
8. budgeting: for those having trouble saving and who can't be bothered to do a budget, the most basic solution is to set up an automatic investment plan. Many banks will offer monthly stock purchase plans which include ETFs. Decide how much to invest each month, which ETFs you want to buy and take 30 minutes to go to the bank and set it up. Do what you want with whatever is left in the bank account after those payments. It's not the best financial plan but it's much better than not saving at all. Anyone who can't be bothered to do even this probably does deserve to fall into the clutches of a financial adviser
Quite frankly, I fail to understand why any high cost financial advisers are still in business.
As a side note, I have yet to find a financial adviser in Hong Kong who only charges by the hour (or flat fee).
Financial advisers cost money. Most charge either a percentage of assets under management or get a commission from anything you invest on or both. There are usually a few other costs thrown in. So what do they offer in exchange for these services? The list may include:
1. basic investment advice: for the most part you don't need this. Even if you want to spend as little time as possible on your investments, reading a few books like The Boogleheads Guide to Investing will be enough to tell you to (i) keep the costs low (ii) go with an equity/bond/cash allocation that suits your age profile, risk tolerance etc. (iii) avoid chasing performance and so on. You don't need an adviser to tell you to do this
2. selecting investments that will outperform: most advisers fail to beat an appropriate benchmark before fees. Even fewer do it after their fees. Past out performance is not a basis for determining future performance. Predicting which advisers will "outperform" is a guessing game with the odds firmly stacked against you. If you want to try and do better than a basic investment investment plan (see #1 above), you need to accept (i) that more work will be involved (ii) the odds are stacked against you (iii) you have a better chance of outperforming if you aren't handicapped by the adviser's fees
3. access to investment products: in the bad old days, there were no ETFs listed in HK, there were no low cost index funds available to the public and it was an exercise in futility trying to access products like Vanguard. Your options were largely (i) buy shares directly or (ii) pay a hefty front end load and a hefty management fee to buy into actively managed funds. Front end loads of up to 5.75% and MERs in excess of 3% pa were not uncommon. And people wondered why the fund penetration rate in Hong Kong was so low. That started to change in November 1999 with the listing of the HK Tracker fund - the first ETF to be listed in Hong Kong. Now there is a wide range of ETFs listed on the HKSE. You pay no front end load on these (only brokerage and other transaction costs which are quite low) and while the typical MER is higher than Vanguard it is still only a fraction of what you would pay for an actively managed fund. It is also easy enough to buy ETFs listed on overseas exchanges if there is something you want but can't find locally. You don't need an adviser to access these - only a broker and a willingness to read the offering document and watch the bid ask spread before you buy
4. domestic tax planning: if your only place of domicile is Hong Kong, you don't need tax advice to make your investments. Hong Kong's tax laws are that simple. Unless you are investing as part of a business, you do not pay taxes on capital gains, you do not pay taxes on dividends and you do not pay tax on interest. There is no estate duty under Hong Kong law. Stamp duties and a few other levies are payable on some investments, but unless you are dealing with very large transactions these cannot be avoided. I see no scope for a financial adviser to add any value here
5. international tax planning: if you are tax resident in another jurisdiction, have assets in another jurisdiction or are a citizen of another jurisdiction, you will probably need to have at least a basic understanding of the tax implications. For most countries the three main issues which need to be considered are (i) withholding taxes on income (ii) application of estate taxes and (iii) liability to pay income taxes. The first two can usually be found with relatively little effort using the Internet. The latter issue will usually require more work and may require the assistance of a professional tax adviser. As a general proposition, if the tax situation is sufficiently complicated that you need an adviser then you need a tax adviser and it would be risky to rely on a financial adviser
6. estate planning: there is no estate duty in Hong Kong. Assets held overseas may or may not be caught in an overseas estate tax regime. There are some legal restrictions on who you can and cannot leave your money to. Depending on circumstances, you may want or need to set up a trust (e.g. to benefit infant children). Advice on these areas is best given by a lawyer (not a financial adviser)
7. insurance: work out how much you need and shop around for the best deal. This applies to term life insurance, medical insurance and home and contents insurance. You don't need a financial adviser to do this for you
8. budgeting: for those having trouble saving and who can't be bothered to do a budget, the most basic solution is to set up an automatic investment plan. Many banks will offer monthly stock purchase plans which include ETFs. Decide how much to invest each month, which ETFs you want to buy and take 30 minutes to go to the bank and set it up. Do what you want with whatever is left in the bank account after those payments. It's not the best financial plan but it's much better than not saving at all. Anyone who can't be bothered to do even this probably does deserve to fall into the clutches of a financial adviser
Quite frankly, I fail to understand why any high cost financial advisers are still in business.
As a side note, I have yet to find a financial adviser in Hong Kong who only charges by the hour (or flat fee).
Thursday, November 11, 2010
Investment services to be avoided
Like may professionals, I get more cold calls from financial advisers than I would like (the preferred number of calls is zero). While standards have improved (very) marginally over the years, most are from "independent" financial advisers selling high cost and inflexible insurance products or off the plan overseas real estate.
This week I received a cold call from a large financial institution, one that I did not have a relationship with. Curiosity got the better of me and I agreed to meet with them to see what they had to offer. I should have known better. I really should have. Their product had the following features:
1. front end load of "only" 2-3% depending on the amount invested;
2. annual management fee of 1.5-2% depending on the amount invested; and
3. annual platform fee of 0.3%.
The very neatly dressed and earnest "senior vice president" assured me that they were completely transparent, that there were no hidden fees or charges etc etc etc
And what did they offer to earn these "completely transparent" fees? Access to thousands of mutual funds, ETFs and individual stocks. Big deal. I can also access thousands of funds, ETFs, individual stocks and other investments without paying those fees.
He also waxed eloquently about the portability of the plan - if I leave Hong Kong, I can keep the same account wherever I live (except the US). Hmmm .... and I can't do that with any of my existing accounts?
He seemed surprised when I told him it was a very unattractive proposal.
I really don't understand why anyone would sign up for something as ridiculous as this.
This week I received a cold call from a large financial institution, one that I did not have a relationship with. Curiosity got the better of me and I agreed to meet with them to see what they had to offer. I should have known better. I really should have. Their product had the following features:
1. front end load of "only" 2-3% depending on the amount invested;
2. annual management fee of 1.5-2% depending on the amount invested; and
3. annual platform fee of 0.3%.
The very neatly dressed and earnest "senior vice president" assured me that they were completely transparent, that there were no hidden fees or charges etc etc etc
And what did they offer to earn these "completely transparent" fees? Access to thousands of mutual funds, ETFs and individual stocks. Big deal. I can also access thousands of funds, ETFs, individual stocks and other investments without paying those fees.
He also waxed eloquently about the portability of the plan - if I leave Hong Kong, I can keep the same account wherever I live (except the US). Hmmm .... and I can't do that with any of my existing accounts?
He seemed surprised when I told him it was a very unattractive proposal.
I really don't understand why anyone would sign up for something as ridiculous as this.
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