Paying only for performance

If you were going to pay someone to invest your money and had agreed that you would pay them only a profit share arrangement how much of the profit would you be willing to share with them? Fifty-fifty perhaps?

Paying only when someone makes you money sounds like an attractive option, but Australian managed funds have traditionally always included a base management fee which you pay even when the fund loses money. New to the market in Australia are two managed funds in which you can profit share – you only pay a percentage fee when the fund makes you money and also outperformance its index. If that interests you then check out the Macquarie Incentives Funds.

The two managed funds over which Macquarie have applied this fee structure are not for the faint hearted. Don’t ever invest just for the fee structure – always ensure the fund investment profile is appropriate to you. (Disclaimer – this is not a recommendation to invest.)

So, back to my original question, how much would you split the profits if paying only for outperformance? In the case of the funds mentioned above Macquarie will keep 35% of the profits and you get to keep the other 65%.

Does that sound fair to you? Please let me know the profit share you think is “fair exchange” by leaving a comment below.

So how risky is the market really?

If you are keen to learn more facts about the risks of investing then Fidelity International have just released some free tools to help you learn.

Visit www.fidelitytools.com.au to:

  • Find out how markets have recovered from various past shocks
  • Check the impact timing your investments could have on your returns
  • See how picking the best stocks could help you beat the market
  • Discover how volatile investment returns can be

The tools are interactive enabling you to vary time periods or look at different market events and even difrent investment markets. Well worth a look.

Focus on your true net returns

Yesterday, Vanguard Investments Australia released some research highlighting the significant impact that tax has on investor’s returns. Read the report here.

The report focuses on the 15 largest wholesale Australian Equity (Share) Funds. Presumably this sample was selected to represent the impact on a majority of investors in such funds.

Tax is a big cost

The analysis highlights the importance of focussing on more than just total return when considering managed fund investments. Of the funds surveyed, on average three-quarters of the total return was in income with the remainder in capital growth. With capital gains in Australia potentially taxed at half that of income, the fact that most of the return was income is a significant cost to the investor.

Vanguard uses the research to highlight the benefit of investing in passive index funds such as their own funds. But I’d like to expand that to encourage you to consider all the costs of investing including tax, transaction costs, advice fees and also your time. All of these impact on your net return and it is your net return that determines how rapidly your wealth increases.

The counter-argument to the one promoted by Vanguard is that people want to get the best returns. Subsequently they are willing to invest time and money in researching actively managed funds that hopefully will deliver higher gross returns to make up for the higher fees and potentially higher tax. But does that actually happen?

Your time is a big cost too

To assess the answer to that question I will focus on the same sector as the Vanguard research: Wholesale Australian Equity funds.

To benchmark the above funds I will use a market index: the S&P/ASX 200 Accumulation index, which returned 28.7 percent for the year to 30th June 2007. (Source: van Eyk Research).

Of the 186 funds in this sector, over the past year nearly three-quarters of the managed funds achieved a gross return after internal management fees at or less than the comparable market index. So they haven’t really added value for their management fee. And if you spent time trying to chase the best returns from an active fund it is likely you haven’t received a reasonable reward for the time you invested.

The picture doesn’t get any better if you expand the view to 3 year or 5 year periods.

Count the total cost

Before spending oodles of hours researching and trying to find “the best” investment consider if it is likely you will get a return for all of the time you invested.

And remember to consider the tax implications of active management. Frequently buying and selling to chase “the best” return may cost you much more in tax thereby counteracting any benefit.

Rather than pouring over the financial pages of the newspaper perhaps you will receive a much better life return by leaving your investments alone and instead sitting down and reading the latest Harry Potter book…

Be wary of league tables

This time every year mainstream media often report on the league tables for investments and superannuation accounts. The reports mostly talk about “the best fund”. Was your fund one of the best? Or have lost money through missed opportunity?

They are unreliable

If your fund doesn’t feature among “the best” don’t despair (yet). I think that these tables are unreliable as a basis for an investment decision.

The tables generally judge the best based on investment performance over the past 12 months. This time frame is way too short to be the basis of an investment decision.

Most of the tables in the newspapers judge performance for multi-sector managed funds that invest across several asset classes. They do this because most people are invested in multi-sector funds. But just because most people are in these funds doesn’t mean they are the best way to get top class performance. If you really want “the best” you need to broaden your scope.

The best superannuation account is often reported based on the performance of its balanced fund. Again the reason is that around 80 percent of Australians are invested in balanced funds. I have two concerns with this judgement:

  • There is no clear definition of what constitutes a “balanced” asset allocation so the funds being compared can be quite different. Hardly a like-for-like basis for annointing “the best”.
  • As above, just because most people are in balanced funds doesn’t mean it is correct to associate the entire super account with the performance of its balanced fund.

Unreliable but useful

Whilst I believe the reported tables are unreliable as a basis for an investment decision the fact they are published in mainstream media is actually quite useful.

The appearance of the reports each year serve as a wonderful reminder to make an annual critical review of the performance of our portfolios and accounts. Particularly if you have changed employers during the past 12 months it is a great idea to review your superannuation accounts.

Click here to learn how to conduct a critical review of your account.

What is the best investment?

One of the most common and frequent questions I am asked is:

“Matt, what is the best investment?”

In the media this question is often covered by delving into some analysis of the current state of the markets. In my opinion that is an incorrect and incomplete approach. So my jaw dropped on Saturday when I read an article in a mainstream newspaper that correctly answered this question. The article was by Marcus Padley and appeared in The West Australian (4th August 2007, page 66).

In his article Padley notes: “The best long-term investment of all is in your own business, your own career, your own development, your own intellect. Far better you invest in that than any equity investment.”

The best investment ever is in yourself. Invest in learning new skills and talents that could earn you higher income. Invest in personal development to better use the tool of your mind to guide your spending and risk assessment decisions. Both of those investments have a long-term exponential reward to your life and wealth.

Padley’s statement is more correct than traditional answers in the media because it considers the larger context of wealth creation.

International author and speaker Anthony Robbins once said: “Successful people ask better questions, and as a result, they get better answers.”

Contextually, anyone who believes that the original question above is a good question would benefit by investing in themselves to learn better wealth creation questions to ask. That will be one key to their success.

Stay tuned, as over time I will reveal better questions to ask yourself and your advisers.