Millionaire Teacher

by Andrew Hallam

  Instead, find a financial services company that charges a flat annual fee.

  Not Interested in a Target Retirement Fund?

  Many Intelligent Investment Firms are popping up in the UK. But few of them use index funds exclusively or offer services to retail investors. Nutmeg, however, is one firm that does. Its costs are high, compared to their Canadian and US counterparts. But Nutmeg offers one of the best values in Britain. As competition heats up, costs will likely lower.

  Table 7.8 shows how much Nutmeg’s investors would pay in fees to have a portfolio of index funds built and managed for them.

  Table 7.8 Nutmeg’s Annual Fees, Based on Account Sizes

  Account Size Annual Account Management Fee

  Estimated Expense Ratio Charges for Index Funds

  Total Annual Costs, Including Management and Fund Expense Ratios

  Below £25,000 0.95%

  0.19%

  1.11%

  £25,000 to £100,000 0.75%

  0.19%

  0.94%

  £100,000 to £500,000 0.50%

  0.19%

  0.69%

  £500,000+ 0.30%

  0.19%

  0.49%

  Source: Nutmeg.com13

  Intelligent Investing Firms for Australians

  Ask an Australian on the street this question: What has performed better, Australian shares or Australian property? Nine out of ten will say that property prices have run circles around Aussie stocks.

  Australian property values have certainly soared. But their stock market hasn’t been too shabby, either.

  According to Philip Soo, a Master’s research student at Deakin University’s School of Humanities and Social Sciences, Australian property prices rose 400 times faster than inflation between 1900 and 2012.14 He sourced such data from the Australian Bureau of Statistics.

  Over the same 112 years, Australian shares have risen 2,208 times faster than inflation. Both asset classes have also done well over the five-year period ending May 31, 2016. According to GlobalPropertyGuide.com, the average house price change measured over eight capital cities saw an increase of about 28 percent.15 Vanguard’s Australian stock market index increased by 37 percent.

  Australians who want a diversified portfolio of indexes could also choose Vanguard. Vanguard Australia offers five Life Strategy funds. They rebalance each of them once a year. The investment costs (as a percentage of the overall assets) decreases as each account grows.

  Each of Vanguard’s Life Strategy funds, which I’ve listed in Table 7.9, cost 0.9 percent per year for the first $50,000 invested; 0.6 percent for the next $50,000 and 0.35 percent for balances above $100,000.

  Table 7.9 Vanguard Australia’s Life Strategy Funds

  Fund Percentage in Stocks

  Percentage in Bonds

  This fund is best suited for . . .

  Vanguard Life Strategy High Growth Fund 90.2%

  9.8%

  Aggressive and young investors

  Vanguard Life Strategy Growth Fund 70.3%

  29.7%

  Moderately aggressive and young investors

  Vanguard Balanced Index 50.2%

  49.8%

  Conservative investors

  Vanguard Life Strategy Conservative Fund 30%

  70%

  Very conservative investors

  Source: Vanguard Australia

  Intelligent Investment Firms on the Rise

  Several intelligent investment firms (robo-advisers) are set to challenge Vanguard. I’ve listed some below. Costs vary, as do their services. But over time, fees for all of these firms, including Vanguard’s, could get reduced as competition ramps up.

  Each of the firms listed in Table 7.10 builds and rebalances portfolios of exchange-traded index funds. Fees differ based on the amount that’s invested. For example, Stockspot doesn’t charge an annual fee for the first 12 months on accounts that are valued below $10,000. They charge 0.924 percent per year for accounts valued below $50,000. They charge 0.528 percent per year for accounts valued above $500,000.

  Table 7.10 Intelligent Investing Firms In Australia

  Firm Annual Fee

  Additional Annual Percentage on Assets Fee

  Estimated Total Annual Fees Including Fund Expense Ratio Costs

  Stockspot $77 0.528% to 0.924% 0.828% to 1.224%

  Ignition Wealth $198 to $396 0 0.3%

  Proadviser $75 0.79% 1.09%

  Quietgrowth $0 0.40% to 0.60% 0.70% to 0.90%

  Vanguard’s Life Strategy Funds $0 0.35% to 0.9% 0.35% to 0.9%

  Let me further explain the above table. Stockspot charges a $77 fee per year to every account holder. They then charge the client a percentage of the account’s value each year. Depending on the account size, that ranges from 0.528 percent to 0.924 percent per year. But the fund companies charge small fees for their ETFs. Stockspot doesn’t take this money. It would go to Vanguard, iShares, or the chosen ETF provider. When adding these estimated fund charges, investors would pay the annual $77 per year plus 0.828 percent to 1.224 percent of their account values each year, depending on their account size.

  Ignition Wealth offers a great deal for investors with larger accounts. It charges a flat fee between $198 and $396 per year. That fee would eat aggressively into a small investment account valued below $10,000. But Ignition Wealth doesn’t charge an annual fee based on the investment account size. It reminds me of what a friend once told me about his Jaguar sports car. “Anyone can keep up with me up to 60 miles per hour. But God help anyone who tries to keep up after that.”

  Intelligent Investment Firms in Singapore

  In late 2016, a couple of robo-advisers were getting ready to launch in Singapore. One of them is called Smartly. They promise to build portfolios of low-cost ETFs.

  This is a big, positive step. Singaporeans deserve a low-cost platform for a portfolio of index funds. But if such firms take shortcuts, somebody might get bit. Based on e-mail exchanges that I have had with these firms, they are planning to use some US-based ETFs.

  For taxable reasons, that’s a dangerous game to play. It’s like saying, “We care about our investors. But let’s toss their heirs in front of an MRT train.” Such firms should build portfolios of ETFs that trade on the Singaporean, Canadian, British, or Australian stock market.

  Here’s why.

  If a Singaporean dies owning US-based assets, the investor’s heirs may have to pay a hefty US estate tax bill if their assets exceed the equivalent of $60,000 USD.

  I can hear what you’re thinking. “I’m not an American. I’m not even using a US brokerage.” That might not matter. The IRS states that “Nonresident’s stock holdings in American companies are subject to estate taxation even though the nonresident held the certificates abroad or registered the certificates in the name of a nominee.”16

  And the tax could be hefty, starting at 18 percent and rising to 40 percent for accounts exceeding $1 million.17

  Table 7.11 lists three portfolios. Each has similar asset allocations that provide exposure to US stocks, international stocks, and international bonds. US estate taxes could slap the first portfolio once the investor dies. But the other two would be safe because the ETFs trade on the Canadian and UK stock exchanges.

  Table 7.11 Singaporeans, Why Take The Extra Risk?

  Could Be Subject to US Estate Taxes Would Not Be Subject to US Estate Taxes Would Not Be Subject to US Estate Taxes

  US Equity Vanguard Total Stock Market ETF (VTI) Vanguard US Total Market ETF (VUN) Vanguard S&P 500 ETF (VUSA or VUSD)

  International Equity Vanguard FTSE Developed Markets ETF (VEA) Vanguard FTSE Developed Markets ETF (VDU) Vanguard FTSE Developed World ETF (VEVE or VDEV)

  Fixed Income iShares 1–3 Year International Treasury Bond ETF (ISHG) Vanguard Global (ex US) Bond ETF (VBG) iShares Global Government Bond UCITS ETF (IGLO)

  Trading Exchange US Canadian UK

  Don’t let a teething robo-adviser in Singapore threaten the money you coul
d bequeath. If you do use such a firm, make sure they don’t build you a portfolio with an ETF that trades on a US stock exchange.

  Don’t Ask about Another Lover

  What would happen if a man asked his lover about the seductive woman who lives across the street? “Should I make the switch?” he might ask. If he asks such a question, he should record his stupidity and upload it onto YouTube.

  He would get millions of hits if he got beaten to a pulp.

  That won’t happen if you ask your financial adviser about index funds. But the same rule applies. If the adviser invests using actively managed funds, she’s not going to be happy.

  She’ll also be armed with a handful of arguments to keep you away from index funds. In the next chapter, I explain what she’ll say. It’s always best to peek inside a pilferer’s playbook.

  Notes

  1Morningstar.com

  2Guru Grades, CXO Advisory, www.cxoadvisory.com/gurus/.

  3Morningstar.com.

  4Interview with Robert Wasilewski via e-mail, April 1, 2014.

  5Interview with Mark Zoril via e-mail, December 5, 2015.

  6Interview with Sonny Wadera via e-mail, December 27, 2014.

  7Personal interview with Tim Godfrey, March 2, 2016, in Victoria, B.C.

  8Personal interview with Deborah Bricks, March 4, 2016, in Victoria, B.C.

  9Personal interview with Marina McKercher, March 8, 2016, in Victoria, B.C.

  10Interview with Dan Bortolotti via e-mail, June 30, 2016.

  11Interview with Katie Dixon via e-mail, June 15, 2016.

  12Personal interview with Neville Joanes, March 10, 2016, by telephone.

  13Nutmeg.com, www.nutmeg.com/our-fee.

  14“The History of Australian Property Values,” MacroBusiness, February 13, 2013, www.macrobusiness.com.au/2013/02/the- history-of-australian-property-values/.

  15“Global Property Guide House Price Changes,” Global Property Guide, www.globalpropertyguide.com/Pacific/Australia/price-change-10-years.

  16“Some Non Residents with U.S. Assets Must File Estate Tax Returns,” IRS, www.irs.gov/individuals/international-taxpayers/some-nonresidents-with-u-s-assets-must-file-estate-tax-returns.

  17“2014 Unified Rate Schedule,” Tax Policy Center, www.taxpolicycenter.org/sites/default/files/legacy/taxfacts/ content/PDF/estate_rates.pdf.

  RULE 8

  Peek inside a Pilferer’s Playbook

  If you’ve read what I’ve written so far about indexed investing, I hope that you’re planning to open your own indexed account. Or perhaps you’ll choose an intelligent investment firm that can set it up for you.

  Either way, if you currently have a financial adviser who’s buying you actively managed mutual funds, you’re probably thinking of making the split.

  That’s always easier said than done. I like to think that the majority of investors who have attended my seminars have decided to index their investments—to save costs and taxes—while building larger accounts than they would have done with baskets of less-efficient products. But not all have. I know many would-be indexers spoke to their financial advisers, fully intending to break free. But the advisers’ sales pitches froze them in their tracks.

  Many financial advisers have mental playbooks. They’re designed to deter would-be index investors. The advisers initiate their strategies with remarkable success. Many of their clients are forced to keep climbing mountains with 100-pound backpacks.

  How Will Most Financial Advisers Fight You?

  Often, when a friend or family member wants to open an investment account, he or she asks me to come along. Beforehand, I briefly talk to the new investor about the markets, how they work, and the merits of index investing. I tell the person that every single academic study done on mutual fund investing points to the same conclusion: to give yourself the best possible odds in the stock market, low-cost index funds are key.

  Walking into a bank or financial services company, we’re then settled into plush chairs across from a financial adviser. The adviser tries to sell us on his ability to pick winning mutual funds. When my friend brings up index funds, the salesperson has an arsenal of anti-index sales talk.

  Here are some of the rebuttals the advisers will give you—desperate, of course, to keep money flowing into their pockets and the firm’s. If you’re prepared for what they’ll say, you’ll have a better chance of standing your ground. Don’t forget. It’s your money, not theirs.

  Index funds are dangerous when stock markets fall. Active fund managers never keep all their eggs in the stock market in case it drops. A stock market index is linked 100 percent to the stock market’s return.

  This is where a salesperson pushes a client’s fear button—suggesting that active managers have the ability to quickly sell stock market assets before the markets drop, saving your mutual fund assets from falling too far during a crash. And then, when the markets are looking “safer” (or so the pitch goes), a mutual fund manager will then buy stocks again, allowing you to ride the wave of profits back as the stock market recovers.

  It all sounds good in sales theory. But they can’t time the market like that—and hidden fees still take their toll. Ask your adviser to tell you which calendar year in recent memory saw the biggest decline. He should say 2008. Ask him if most actively managed funds beat the total stock market index during 2008. If he says yes, then you’ve caught him talking out the side of his head. A Standard & Poor’s study cited in The Wall Street Journal in 2009 detailed the truth: the vast majority of actively managed funds still lost to their counterpart stock market indexes during 2008—the worst market drop in recent memory.1 Clearly, actively managed fund managers weren’t able to dive out of the markets on time.

  What’s more, a single stock market index is just part of a portfolio. Don’t let an adviser fool you with data comparing a single index fund with the actively managed products they’re selling. As you read in Chapter 5, smart investors balance their portfolios with bond indexes as well.

  You can’t beat the market with an index fund, they’ll say. An index fund will give you just an average return. Why saddle yourself with mediocrity when we have teams of people to select the best funds for you?

  I’ve heard this from a number of advisers. And it makes me smile. If the average mutual fund had no costs associated with it—no 12B1 fee, no expense ratio, no taxable liability, no sales commissions or adviser trailer fees, and no operational costs—then the salesperson would be right. A total stock market index fund’s return would be pretty close to “average.” Long term, roughly half of the world’s actively managed funds would beat the world stock market index, and roughly half of the world’s funds would be beaten by the index. But for that to happen, you would have to live in the following fantasy world:

  Your adviser would have to work for free. No trailer fees or sales commissions for him/her or the firm. The tooth fairy would pay his mortgage, food bills, vacations, and other worldly expenses.

  The fund company wouldn’t make any money. Companies such as Raymond James, T. Rowe Price, Fidelity, Putnam Investments, Goldman Sachs (and the rest of the “for-profit” wealth-management businesses) would be charitable foundations.

  The researchers would work for free. Not only would the fund companies bless the world with their services, but their researchers would have to be altruistic, independently wealthy philanthropists giving their time and efforts to humanity.

  The fund managers doing the buying and selling for the mutual funds would work for free. They would be so inspired by their parent companies that they would trade stocks and bonds for free while lesser-evolved mortals worked for salaries.

  The fund companies could trade stocks for free. Large brokerage firms would take the financial hit for the trading done by mutual fund companies. Recognizing the fund companies’ “value-added” mission, brokerage firms would pay every commission a fund company racked up from trading stocks.

  Governments would waive your taxable obligations. Because
the fund companies are such a blessing on the world, the world’s governments would turn a blind eye to the taxable turnover established.

  If the fantasy scenario above were correct, then yes, a total stock market index fund would generate very close to an average return.

  But in the real world, advisers suggesting that a total stock market index gives an average return are proving to be well-dressed Pinocchios or post-Columbus sailors with a “Flat Earth” complex.

  A tough salesperson, however, wouldn’t stop there. Next, you might hear something like this:

  I can show you plenty of mutual funds that have beaten the indexes. We’d only buy you the very best funds.

  It’s pretty easy to look in the rearview mirror at the last 15 winners of Golf’s British Open Championship and say: “See, here are the champions who won the British Open over the past 15 years. These are people who can win. This knowledge qualifies me to pick the next 15 years’ worth of champions—and we’ll bet your money on my selections.”

  Studies prove that high-performing funds of the past rarely continue their outperforming ways.

  Just look at the system used by Morningstar’s mutual fund rating system. No one in the world has more mutual fund data than Morningstar. Certainly, your local financial adviser doesn’t. But as detailed in Chapter 3, the funds given “top scores” by Morningstar for their superb, consistent performance usually go on to lose to the market indexes in the following years.

  Even Morningstar recognizes the incongruity. John Rekenthaler, director of research, said in the fall 2000 edition of In the Vanguard: “To be fair, I don’t think that you’d want to pay much attention to Morningstar’s ratings either.”2