Efficiency Matters: Part 2
What do you do when you discover that your electricity can be provided cheaper by another supplier? Get angry? Switch? Call up your provider and complain? Do nothing? How would you feel if your utility provider could provide its services 2% cheaper a year?
Inertia could be doing the most damage to your investment portfolio. Here’s how:
1. The cost to custody your investments and the cost of your investment wrapper
Your investments will be held in custody on a platform. The platform will charge you for simply holding your investment portfolio there. In the UK and Europe this cost can range from 0.15%-0.50% of the value of your account. In the US such custody charges are typcially a fixed amount, for example, $10-$50/year per account. As an American living in the UK this is one area where you can make a difference by utilising US platforms and custodians. Trading costs can also add up. In the UK and Europe the cost of trading can vary between £25-£50/trade to an actual percentage of the amount being traded. In the US trading costs are typically $10-$20 depending on the security being traded.
Tax deferred investments will also be held in what is known as a wrapper. For example, an Individual Retirement Account (IRA) in the US or a Self Invested Personal Pension (SIPP) in the UK. Such wrappers have annual charges from the provider. Although not high you should ensure that you are not duplicating these charges by having multiple US retirement accounts or incurring unnecessary charges on wrappers that are not necessarily tax efficient for US taxpayers such as ISAs or offshore bonds.
2. The cost of the investments in your portfolio
As an investor you may have been involved in the set-up and initial purchases in your portfolio. You may even have worked with a financial advisor. What you may not have been aware of, or been made aware of, is the cost (expense) of the investments you have selected. Typically funds favoured by retail investors will have a management charge of between 1%-1.5% of your holdings in that fund. You do not see this on the statements you are sent by your custodian but they can be found in the fund prospectuses (which they are required to publish). Not all fund charges are so high. Institutional and index funds will charge as little as 0.10%-0.30% saving you around 1% (depending on your existing portfolio).
If you are invested in a stock only portfolio you should sit down and add up the trading costs your investment manager (or you) have incurred over the year. You will be surprised.
3. Inattentive portfolio management
Let us assume that you have found the right platform, wrapper and investment products. What next? How do you decide to build your portfolio? Academic research shows that asset allocation (the allocation of your investments between fixed income (bonds), equities and alternatives) is the main driver of investment returns. After some research you decide to invest 60% of your cash into investments and 40% into fixed income. Well done. You sleep safely at night knowing you have fixed the costs and set your investments on the right path.
Most people will now forget about their investments….. for a long time. When you next check in, say 9 months, you may be surprised to find that your equities have grown to represent 70% of your portfolio whilst the fixed income has fallen to only 30% of your original portfolio. You probably feel really pleased about the growth in the equity portion of your portfolio. In reality, you have unwittingly taken on more risk (we will discuss this in later blogs) and are subjecting your hard earned investments to more volatility by having a greater exposure to equities and therefore greater exposure to potential losses and inefficiency.
The solution to this is constant portfolio monitoring allied with decision-making about when to rebalance a portfolio. We would suggest that this is also where a professional investment advisor adds value.
4. Sticking to original investment strategy
As in point 3 above, we regularly meet clients who are comfortable with an existing financial advisor whilst also admitting they have not met that advisor for a number of years (or since they moved to the UK). When they first started out with the advisor they agreed a strategy based on a number of factors: their personal goals, their tolerance and attitude to risk, planned future contributions to their accounts, etc. However, as Ralph Waldo Emerson once said, “Life is a journey not a destination”. Things change. For example if you are reading this as a US expat living in the UK did you change your financial and investment plan to take account of that move?
There are many factors that will lead you to change your personal financial goals and possibly even your views on risk. An advisor who implements regular reviews will keep you on track and ensure that your investment strategy changes accordingly.
5. Finally – Be Advised.
The point has been touched upon but is now worth reiterating. A financial advisor is a professional. They will provide a service. At the very least they will set out a financial plan with you. At the very best they will ensure that your accounts are held on the most appropriate platform, that your investment portfolios are invested in the most cost efficient manner and that they are aligned with your goals, constantly reviewed and most importantly adjusted when your life changes. They will work with your other professional advisors to give you peace of mind.
At Tanager Wealth Management we have developed a complementary service called The Bird’s Eye View designed to look at your current investments and their structure and provide you with feedback on how efficient they are for you. Please contact us to discuss how we can help.
