There are new UAE rules regarding insurance products about to be introduced. They will benefit the consumer but I still think they do not go far enough.
Most of my readers know that I am not a fan of insurance backed investment products, due to the lack of flexibility. The fees involved, the punishing exit fees, the lack of clarity no disclosure and almost impossible to make money.
It is because I believe that the costs still far outweigh any service received. To quote one of my favourite investors Warren Buffet:
If clients knew what they were paying for a typical insurance backed savings account. they would run a mile. 18 months’ premium in fees? Redemption fees that wipe almost wipe out your savings. Total fee structures that can work out about 6% p.a.
There is a change coming, the industry is fighting this change, but it will come.
Let’s look at alternatives.
There are three ways we can invest or save.
- DIY investing: cheaper and can be fun with lots of risk and most likely underperformance.
- Advisor directed: a qualified advisor giving advice, you say yes and “caveat emptor” is the result.
- Discretionary investment management can only be offered by individuals who have extensive experience in the investment industry and advanced educational credentials, with many investment managers possessing the Chartered Financial Analyst (CFA) designation. Discretionary investment management used to be generally only offered to high net worth clients who have a significant level of investable assets. However this is now changing and can even be used on a savings account.
If only it were that simple.
Yes, fees do make a difference, but unless you put all the pieces of the puzzle together it will not work.
What will affect my returns
- Advisor remuneration
- Market timing
- Asset allocation
- Investor psychology
Paying exorbitant commissions does not mean you get value. The higher the total fees, the more you must make just to stand still.
Fees can be broken down to
- Advisory fees
- Platform fees
- Transactional fees
- Discretionary management fees
- Fees within the underlying assets such as mutual funds, Exchange traded funds etc.
It is imperative that you get all these fees to below 2% p.a.
- Advisor remuneration:
If an advisor is paid commission, he has a short-term goal and little incentive to look after the client long term. As such the investment structure, may be good for today, however where should you be tomorrow?
If an advisor is paid an ongoing fee, he is rewarded if he looks after the client. As client’s needs change then the advisor will be there to help and advise. When the markets get volatile the advisor will be the steady hand guiding you past these difficult times.
Compensation drives behavior, the wrong compensation drives the wrong behavior.
Ensure that the advisors goals are aligned with yours.
- Market timing:
I can name many top investment managers, but I am unable to mention one single top market timer for the simple reason that market timing does not work
There is empirical information that shows that market timers underperform most times.
In fact, market timing is one of the most dangerous words when it comes to investing.
Just as people go to Vegas to beat the bank, some may beat the bank, however most will not.
Market timing will often result in not being in the market when it goes through above average returns.
The market returned 8.18% on average during these 20 years.
However, if you missed the best 10 days then returns dropped to an average of 4.49%.
If you missed the best 20 days during these 20 years, the returns dropped to 2.05%
60% of those best days happened within 10 days of the worst days.
I.e. when the market capitulates, you are either already out or this is where most now leave. They then miss this massive rebound. That is why we have this huge under performance.
- Asset allocation:
Asset allocation has a bigger effect on people’s portfolios than one imagines.
Diversification reduces risk and volatility. Many people buy different equity investments and think that they have diversified. However, if they are similar assets all you have is a concentration of risk without even realizing until it is too late.
To give you an idea, we have seen equity drawdowns from peak to trough of 54.5% yet a diversified portfolio into low or non-correlated assets would have seen peak to trough of about 25%.
In fact, over a 20-year period an asset allocation model had an average return of 8.27% (20-year average to Dec 2013) while the S&P average was 8.11%
- Investor psychology:
We often hear about performance numbers, but as Winston Churchill once said “I only believe in statistics that I doctored myself. Herein lies the problem.
The stock market returned on average 8.18% (S&P 500 1996-2015) however the average investor only managed about 4.5% during the same period.
Why such a discrepancy? A. Investor Psychology.
An investor will use his logical thought process to help determine his risk profile. However, when markets get volatile the investor then reverts to emotional behavior.
The result is panic and exiting the market and beginning to revert to market timing. This is the worst thing that can happen.
One of the ways to prevent emotional decisions is to work with an advisor who will guide you through these tough times or to have your funds managed by a professional discretionary manager.
- Very hard to do yourself.
- Keep costs low
- Your advisor is your employee, the advisor is not a friend, he performs a service and is paid for it.
- Only fools think they will win long term with market timing. It does not work.
- Spread your risk in different asset classes
- Remove your emotional buying and selling decisions by having your portfolio managed by professionals.
Gordon Robertson ACSI
Investme Financial Services LLC – Dubai