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Financial Happenings Blog
Wednesday, November 26 2008

The latest edition of our fortnightly email newsletter was sent to subscribers Tuesday 25th November. 

In this edition we consider the basics of income planning, take a look at CommSec's iPod Index, provide a summary of the movements in markets over the past fortnight and look at the link between the economic cycle and share market returns.


We are also pleased to continue with the new section looking at case studies this week looking at a couple with $1 million to invest.

If you would like to be added to the mailing list please click the following link to be taken to the sign up page - The Financial Fortnight That Was Sign Up Page.

The following is the lead article for the latest newsletter:

Financial Topic Demystified - Income Planning

Earlier this week we sent out an email to all of our clients.  In it we made some brief comments about the current market conditions.  Included with this email was our rationale for continuing to hold equities within an investment portfolio.  In our conclusion we reminded clients of what we consider an absolute key consideration when building investment portfolios - holding enough cash and fixed interest assets to cover income needs for the medium term while still exposing portfolios to growth assets to take advantage of the long term returns from these assets.   We call this income planning and wanted to take the time to remind readers of this concept by providing an extract from our book "A Clear Direction - Being a Successful CEO of Your Life" covering this topic.


Once you are retired (whether this be 40 for some or a little later for others), the aim is to replace your 'personal exertion income' (i.e. your income from your job) with your investments - possibly supported by some Centrelink benefits such as the age pension.
A great way to look at this process is using 'income planning'.  This involves construction of your investment portfolio with your income needs being a critical part of this process.
Let us consider 'income planning' by looking at a case study.
The couple in question are 65 years of age, retired, with $600,000 in superannuation and a further $50,000 in 'lifestyle assets' that Centrelink assess for the sake of the assets test (things like their furniture and car).  They own their own home.
As a couple they are eligible for approximately $7,500 of the age pension (based on pension levels at September 2008). 
Clearly this is not enough to live on, so they decide to draw on their superannuation portfolio at the rate of approximately 5% a year, or $30,000 a year.
So the couple needs to plan for an income of $30,000 a year to be provided from their $600,000 superannuation portfolio.
In the investment world there are two key types of investments.  The first are often referred to as 'Defensive' investments, such as cash accounts and term deposits - as well as other high quality fixed interest investments like bonds.  These offer very reliable short term returns, usually with easy access to the money.  Their downside is that they don't offer very good long term returns compared to shares and property (average defensive returns over a period might be 6% a year; where shares and property might be 12% a year).
The other investments are 'growth' investments, such as shares and property.  In the short term they offer volatile returns - however in the long run (7 to 10 years) they offer returns higher than defensive investments.
A reasonable conclusion to draw from this is that defensive investments offer a great short term option, and growth investments offer a great long term option.
This hardly sounds profound, yet sits as the basis for 'income planning'.
The couple in the case study, with $600,000 in superannuation and looking to draw on this at the rate of $30,000 a year, can plan to keep the money that they need in the short term in defensive investments, with the remainder in growth assets.
They might set aside 5 years ($150,000) in cash and fixed interest investments - to be sure that they have at least 5 years of living costs set aside.  This should allow them to sleep soundly at night - they know where their next 5 years of income comes from.
The remainder is invested in growth assets - such as shares and property investments - which benefit from the higher returns that growth assets provide that cash.  These assets are volatile (may rise and fall in value) - however the couple don't have to be concerned with that because they know that they have the money to fund their next 5 years of living costs.
Over the 5 years, there will also be interest received from the cash and fixed interest investments, dividends from the shares, distributions from the property and so on.  In fact, it is not unreasonable to think that a well put together portfolio of $600,000 will pay gross income (including the tax benefits of franking credits) of at least 5% a year - so there is a further $30,000 a year being received by the portfolio.  Because some of this income comes from share and property investments, it will grow over time, helping the portfolio provide an income that will keep up with inflation.
Given that 5 years of living costs are set aside in cash and fixed interest investments, and the portfolio is generating a growing income stream of at least $30,000 a year, then the couple seem to be in a really strong position to fund their retirement - using defensive investments to provide short term certainty and growth assets (shares and property) to provide the higher long term returns.


How Do We Apply This?


We use income planning in conjunction with risk profiling to come to a conclusion on the ideal amount of cash and fixed interest assets a client should hold or aim to hold when they commence drawing income from their investments.  In times like now it provides a deal of re-assurance that you can ride out down turns in growth asset prices without needing to sell investments to pay for your cost of living.
Posted by: Scott Keefer AT 08:11 am   |  Permalink   |  Email
Wednesday, November 26 2008

A financial advice firm which follows a very similar approach to ours in the USA is Merriman Berkman Next.  You may have noted that we have made a number of references to items on their website and included their website as a recommended website in our email newsletter.

Today they have published a question from a concerned client along with the response from Paul Merriman, founder of the firm, - My finances are getting uncomfortable. What do I do now?  It is well worth a read.

In summary, the client asks whether it is foolhardy to keep hanging on to equities. Merriman responds by stating that:

- he does not know the future and therefore does not have a perfect answer
- he openly acknowledges that the problems facing the global economy are challenging ones without quick, easy fixes but they do now have everybody's full attention.
- he believes that the past, which is our only indicative guide, shows that diversification will be an investor's friend going forward
- it might be time to reconsider asset allocations and how much risk needs to be taken on to reach future goals
- going to cash reall is a question of the philosophy you follow - are you going to follow a buy and hold strategy going forward or follow a market timing strategy?  He suggests that market timing is actually much more of a psychological challenge as you now need to be constantly evaluating when to sell and when to buy

Merriman's conclusion is that every investor has two primary jobs - to manage your risk and to manage your emotions.

Both are being put to the test in the current climate and it is important to be talking through both with your financial advisor if you are questioning either.

Scott Keefer

Posted by: Scott Keefer AT 06:26 am   |  Permalink   |  Email
Monday, November 17 2008

It would be an absolute understatement to suggest that 2008 has been a difficult year for investors and their financial advisors.  These difficulties have confirmed to us the importance of regular dialogue with clients regarding their specific portfolio as well as more generally about investment markets.  It has also highlighted to us the importance of being totally available for client questions and discussions.  We both comment that these phone discussions, meetings and email discussions are the best part of our work.

It is hard to give prospective clients a sense of what this ongoing communication involves so we have tried to provide a few more details on our Portfolio Management Service & Fees page outlining the communication we have had with our clients over the past 12 months.  For those interested, a summary of these points of contact follow:

November 2007 - Provided a copy of an article written by Alan Kohler and discussed the topics of international share investments including currency hedging, the non acceptance of commissions, the problem of ownership bias, avoidance of hedge fund investments and an explanation of why we use wraps.

December 2007 - Provided an article providing insights into why we build investment portfolios the way that we do.

January 2008 - Provided copies of a couple of articles along with thoughts on on the current market volatility, income planning, cash & fixed interest part of portfolios, the importance of discipline and the risk of overreaction, the resilience of sharemarkets, the Australian advantage of income and a look at property trusts.

February 2008 - Provided thoughts on the following topics - importance of cash and fixed interest investments, the strength of company earnings in the sharemarket (PE ratio), the growth of company earnings, the risk of selling share investments or changing strategy, whether stock picking or "normal" managed funds provide a better return in the current environment, and avoiding the financial collapses that seem common.

March 2008 - Discussed an article written by Ross Gittens,  looked at the underperformance of an alternative "value" investment approach taken by Clime Capital, discussed the issue of companies and investment schemes under stress, and pointed out that sometimes the best investments are the ones you don't make.

March 2008 - Held client seminar looking at current market movements and our response to the current situation.

April 2008
- Sent out March quarter portfolio reviews.

June 2008 - Discussion of the following topics - recent broker consensus reports on the Australian share market, Vanguard's quarterly report on investment markets, what else you could be investing in and why we were not recommending these products, a number of articles looking at our investment approach, upcoming income distributions, 3 booklets produced by Vanguard on realistic sharemarket expectations, index investing and investing for income, and implementation of our fee reduction program.

July 2008
- Discussion of the following topics - scenario planning if the share market were to fall a further 30%, expert stock picks and their subsequent performance, and commentary on investment performance within portfolios.

August 2008 - Sent out 2007/08 income report and included a discussion of whether we should be using unlisted assets in portfolios along with an article putting the current market situation into perspective.

Early September 2008 - Discussion of the following topics - performance for the quarter so far including the impact of the fall in the Aussie dollar, look at earnings growth following the annual reporting season, an article produced by Dimensional looking at how their trusts had held up over the year ending June 30, Vanguard's Australian Sharemarket Volatility Chart, an article looking at past quotes regarding "unprecedented" events that tested investor confidence and an update of our referral program and KIVA lending.

Late September 2008 - Discussion of the following topics - market commentary, our investment philosophy, Macquarie Bank and our approach to reduce costs of the bsuiness and in turn costs for clients.

Late September 2008 - Held client seminar and teleconference looking at the credit crisis and our response to these developments.

October 2008 - Sent out September quarter portfolio reviews along with a discussion of the problems in markets, the government guarantee of bank deposits and looking at a recent article written by Warren Buffett.

Scott Keefer

Posted by: Scott Keefer AT 08:35 pm   |  Permalink   |  Email
Sunday, November 16 2008

Users of our website, through our User Voice feedback forum, have requested that we regularly update the graphs outlining the performance of the Dimensional trusts that we use in building portfolios for clients.  In response to this feedback we have updated these graphs to reflect performance up to the end of October 2008.

Starting this month we have also added 7 year performance graphs for all Australian trusts and all global trusts.


Unsurprisingly, the graphs show strongly negative monthly returns over October for all sections of Australian and international markets. In particular, the Australian Small Company, Australian Value trust, Australian ASX200 index and the global Emerging Markets trusts have seen the strongest falls.

Over the long run, the graphs continue to clearly show the existence of the risk premiums (small, value and emerging markets) that the research tells us should exist:

Australian Share Trusts - 7 Year returns


7 Yr Return

to Oct 2008

Premium over ASX 200

Accumulation Index

ASX 200 Accumulation Index



Dimensional Australian Value Trust



Dimensional Australian Small Company Trust



International Share Trusts - 7 Year returns


7 Yr Return

to Oct 2008

Premium over MSCI World (ex Australia) Index

MSCI World (ex Australia) Index



Dimensional Global Value Trust



Dimensional Global Small Company Trust



Dimensional Emerging Markets Trust



NB - These premiums are higher than what we would expect going forward.

Please click on the following link to be taken to the graphs - Dimensional Fund Performance Graphs.

For anyone new to our website, it is important to point out that we build investment portfolios for clients based on the best available academic research.  Take a look at our Building Portfolios and Our Research Based Approach pages for more details.  In our view, this research compels us to use the three factor model developed by Fama and French.  In Australia, the most effective method of investing using this model is through trusts implemented by Dimensional Fund Advisors (  We do not receive any form of commission or payment from Dimensional for using their trusts.  We use them because they provide the returns clients are entitled to from share markets.

However, academic theory is nothing if it can not be implemented and provide the returns that are promised by the research.  Therefore, we like to provide the historical returns of the funds that we use to build investment portfolios.

Please let us know if you have any feedback regarding these graphs by using the Request for More Information form to the right or via our User Voice feedback forum.

Scott Keefer

Posted by: Scott Keefer AT 10:55 pm   |  Permalink   |  Email
Sunday, November 16 2008

In the latest edition of the Sound Investing podcast, published by, Paul Merriman, Tom Cock and Don McDonald discuss stock pickers failing during bear markets, why you should buy stocks now, and myth or reality - professionals beat amateurs at investing.


One warning, the radio show is 51 minutes in length and will use up 47MB of download.


If these constraints are not a problem, I recommend you take a look at the latest podcast - Sound Investing - November 14, 2008


For those who have limited time and/or limited download capability the following is a brief summary of the more relevant material that was covered:


Stock Pickers Fail During Bear Markets

The presenters discuss a recent piece of research conducted by the Vanguard group which shows that in 3 of the last 6 bear markets since 1970 the majority of active managers have failed to beat the relevant market index.


Paul Merriman comments that investors do need to become active, actively taking responsibility for their investments by making changes to decrease expenses, turnover and taxes and to get into asset classes that are in your best interests.


Why should you be buying shares now?

The presenters comment on a recent article written by Knight Kiplinger suggesting now is a great buying opportunity and a wise approach is through dollar cost averaging.


Pau Merriman commented that we can not absolutely depend on the past as a guide to the future.  However, in 1973-74, if you adjusted the losses for inflation a 40/60 strategy has experienced almost the same losses as now.  After 73-74, a diversified portfolio over the next 2 years provided a 34% per annum return.  After October 1987, a diversified portfolio provided a 24% per annum return over the next two years and after the declines of 2001-02, a diversified portfolio provided returns of 25% per annum over the next 2 years.  Finally, after the 1929-32 period the next two years saw a compound rate of return of 23% per annum over the next two years and 47% per annum over the 4 years after 1932.


The key point, investors with staying power won the day.


Back to the Basics

Don McDonald reminds listeners not to invest in investments which you do not understand.


Merriman's Simple Steps

Paul Merriman listed his simple steps to success:

  • Own the right asset classes
  • Own the right amount of equities and fixed income investments
  • Control expenses
  • Control hidden charges
  • Know your risk tolerance
  • Know how to take money out in a low risk way
  • Have enough information so that you understand your investments
  • Allow markets to do their thing

Myth or Reality: Professional investors have an advantage over amateurs

The presenters suggested that the proxy for professional investors were mutual funds (actively managed funds in our language).  From 1980 to 2005 mutual funds provided investors a compound annualised rate of return of 10%.  If an investor had invested in the S&P 500 they would have received a 12.5% compound rate of return.


The conclusion an average amateur investor who invests in an index fund is likely to be more successful than professional investors.



Scott Keefer

Posted by: Scott Keefer AT 07:00 pm   |  Permalink   |  Email
Sunday, November 16 2008

Last Saturday, 15th November, Scott Francis joined Warren Boland's "Weekends with Warren" program on 612 ABC Brisbane.  The major topics covered were:

1. The Four Factors Weighing on Share Markets
2. The Role of Interest Rates
3. The Difficulty of Forecasting

Click on the following link to be taken to a summary of the material covered in the segment - Four Factors Weighing on share Markets / Interest Rates / Difficulty of Forecasting

Posted by: AT 04:52 pm   |  Permalink   |  Email
Tuesday, November 11 2008

Any introductory economics course will have at its heart theories surrounding the business / economic cycle.  The basics of this theory is that economies go through cycles moving from periods of expansion into contraction and then back to expansion.  The basic point of economic policy is to try to smooth out these cycles so that we do not have too strong growth leading to high price increases (inflation) or stong contraction leading to high levels of unemployment.

A lot of the talk in the media is whether we are moving towards or are already in one of those contractionary periods.  The technical term is a recession and the technical definition of a recession is a continuous period of two quarters (6 months) of negative growth.

Unfortunately we can only be sure about whether we have had a recession after the fact.  But even if we knew where we were on the economic cycle how does this flow through to the investment world?

A small article in today's Australian newspaper discusses an investor's perspective of the recession debate - "Future strategy easy in retrospect".  The original article was written for the Wall Street Journal by David Gaffen.

In the article Gaffen points out that investors start discounting an economic recovery about halfway through a recession which prompts a rise in stocks that continues as the economy picks up steam.  However two pieces ofthe puzzle are missing:

1. When has the recession started?
2. When is it going to end?

He suggests that many believe that a recession began in the US somewhere around the first quarter of this year.  In the 16 periods of economic contraction in the US since 1919, the average length of the contraction has been 13 months.  And the conclusion he makes is that the US recession is at or even past the halfway point.  (To add some further perspective, the two worst recessions of recent times began in November 1973 and July 1981 and both ran for 16 months)

Based on this analysis , have markets already priced in the recession and shouldn't we be jumping in boots and all into equity markets?

Unfortunately, Gaffen goes on to point out that the recession this time might be worse than average and we may not make halfway for another few months yet.

Whichever way you lean on the recession, this discussion provides an interesting perspective and some hope that the worst of the declines at least might be behind us.  We will never know until years down the track.

Scott Keefer

Posted by: Scott Keefer AT 06:50 pm   |  Permalink   |  Email
Tuesday, November 11 2008

An article written by Scott Francis has been published in the ASX Investor Update Email Newsletter for November - Strategies for volatile times.  A copy can also be found on the ASX website.

The key points from the article are:
- The risk of timing markets
- Building an effective asset allocation

Scott concludes by providing an example based on a couple about to retire with $700,000 of assets.

Posted by: AT 06:35 am   |  Permalink   |  Email
Monday, November 10 2008

The latest edition of our fortnightly email newsletter was sent to subscribers today - Tuesday 11th November. 

In this edition we take a look at the reasons why we favour passive investing, we take a look at the Prosperity Index, provide a summary of the movements in markets over the past fortnight and look at the case for being careful with only investing in cash.


We are also pleased to provide a link to a new online service comparing credit cards, loans and deposit accounts in the Australian market place as well as introducing a new section to the newsletter looking at case studies as requested by users of our website and this newsletter.

If you would like to be added to the mailing list please click the following link to be taken to the sign up page - The Financial Fortnight That Was Sign Up Page.

The following is the lead article for the newsletter:

Financial Topic Demystified - Passive Investing

A natural question to be asking, in the midst of what is one of the worst share market declines in history, is what investment approach is going to serve you best going forward.  Our firm remains committed to a passive approach to investing.  In this edition we want to spell out why we favour this approach.


The following is taken from our latest book - A Clear Direction - Being a Successful CEO of Your Life.




In earlier chapters we looked at managed funds and saw that they were ineffective investment vehicles when compared to the simpler strategy of investing in index funds.  We also saw that passive funds that capture the small company and value company premiums discovered by Fama and French in the early 1990's allow passive investors to build portfolios that will outperform the simple index.


We looked at the importance of asset allocation and discussed the fact that asset allocation is the key driver of investment returns.  By using passive funds we are able to focus on building an asset allocation that suits the requirements of each investor.

This chapter sets out some advantages of using index and passive funds to build an investment portfolio.  Some of the issues have been touched on in previous parts of the book.  However it does not hurt to review them.  The six areas of advantage that index and passive funds have over active management include:


  • Tax Efficiency
  • Reduced Market Impact
  • Research Costs
  • Portfolio Asset Allocation Control
  • Diversification
  • Fees

As we saw in the early chapters of this book passive and index funds also have the important attribute of providing above average investment returns.  For this section of the book let's focus on the six points listed above, and consider these one at a time.


Tax Efficiency


Active management, regardless of whether it is done by a managed fund, stockbroker or an individual assumes that you are going to actively make investment decisions over time that will result in a higher than average portfolio performance.  These decisions mean that you will have to buy and sell investments. 


Each time you buy or sell an investment you have to pay capital gains tax, assuming that the investment has increased in value.  This applies even if you are an investor in a managed fund.  If the fund manager sells an investment at a profit you become liable to pay capital gains tax on this profit at the end of the financial year.


An interesting way to think about an unrealised capital gain that you have in an investment is that it is 'an interest free loan from the tax department'.  (An unrealised gain is where an investment has made a gain, however you have not yet sold the investment.  So the gain is described as 'unrealised'.)  As soon as you sell the investment you will have a tax obligation that will need to be paid.  However, if you never sell the investment then you will never have to pay that capital gain.


Therein lay the tax efficiency of passive investing.  If all the underlying investment manager is doing is tracking an index or subsection of the index, then there is little need for any trading.  Less trading means less realised capital gains, and more 'interest free loans from the tax department' in your underlying investment portfolio.


Using market figures from the Australian Stock Exchange website (, we calculated the total turnover for the Australian Stock Exchange in the 12 months to November 2005 as being 89.4% - great for the shareholders of the ASX who generate revenue every trade, but perhaps not so great for investors who have to pay tax on every profitable trade.   We actually find this level of share trading quite staggering.  A nearly 90% sharemarket turnover implies that every 13 or 14 months every single investment on the Australian stock exchange is traded.  Clearly index funds are not trading much at all, so the remaining market participants must have very high levels of trading in their portfolios.


Reduced Market Impact


A key problem with managing large sums of money in structures such as managed funds is that when a large fund manager wants to buy or sell an investment they end up moving the price of that investment against themselves.  For example, if a fund manager wanted to take a $40 million position in a listed company such as Leightons, their demand for shares would be pushing the price of the shares up as they bought in.  Similarly, when they decided to sell their stake in Leightons, their $40 million of shares would mean an oversupply of sellers and therefore push the price of the shares down.  This market impact effect sees the price of the shares increase as the fund manager buys and decrease as the fund manager sells, reducing the expected return from the investment.


Index funds have less of a problem in this regard.  Firstly, they are trading less than active market participants, so have fewer trades that can be affected by market impact.  Secondly they own all of the companies in an index, so they have their capital more evenly spread over all the investments in a market, rather than just the 30 or 40 that might be targeted by an active manager. 


Market impact costs, exacerbated by the high level of trading by fund managers, are largely avoided with index funds.


Research Costs


There are many levels of research services that offer advice to investors on which managed funds to invest in or which individual shares to buy.  These include services such as:

  • Portfolio management services that manage direct share portfolios for investors
  • Investment newsletters and stock picking sheets
  • Services that help select managed funds
  • Financial planners that help select managed funds for a commission payment

With index funds these services are no longer important.  An index fund is a simple 'commodity' that investors should feel confident choosing themselves based on the price of the fund.  All Australian share funds based on the ASX200 will be almost exactly the same, and investors should be confident simply choosing the cheapest fund.


Portfolio Asset Allocation Control


This book has presented significant evidence that asset allocation is the primary driver of portfolio performance.  Using index funds that mirror each asset class, and in the case of small companies and value companies passive funds that provide exposure to sub-asset classes, the focus can be taken away from the investment selection process and onto building a portfolio with an asset allocation that best suites each investor.


The adoption of index investment and passive investment is something that should empower individuals to be more closely involved in their own investment process.  The simplicity and effectiveness of indexing and passive investment means that investors are no longer compelled to pay high fees to the financial services industry for mediocre results.




That indexing and passive investment allows a great deal of diversification is not hard to understand.  For example, an index fund based around the 200 largest stocks in the Australian share market will have 200 investments in its portfolio.  This minimises the impact that a fall in value of any one investment can have on your portfolio, the key advantage of diversification. 


Once you start to get into the world of active management it is almost a given that the portfolios formed will be less diversified than the underlying index.  However, active investment managers often choose to have well diversified portfolios.


Here is a fundamental problem for active management.  Let's call it the third paradox of active management.  The more diversified an investment portfolio becomes the more it will look like the underlying investment index, and the less it becomes able or likely to outperform the index.  The paradox is this: most active fund managers and investment managers exist because of their belief that they have 'skill' that can beat the relevant investment index; however they also believe in diversification as a risk management tool.  If active fund managers really believed in their skill at picking outperforming investments, surely they would only choose the best 10 - 15 investment ideas to hold in their portfolio!  If they have the ability to pick better performing investments, then why not just hold the very best of their ideas?  Why water these best ideas down with diversification?


Consider a large company fund invested from the top 200 companies in the Australian Stock Exchange.  Large investment managers are always touting the idea of 'diversification' as a way of managing risk and often hold portfolios that consist of the majority of the investments in an index.  Suddenly active management starts to look very much like very expensive index management, an issue addressed in a recent academic study.


Ross Miller, in his paper 'Measuring the True Cost of Active Management by Mutual Funds', sets out to identify how much the returns from mutual funds (US term for a managed funds), are a result of closet indexing and how much they are a result of active management unrelated to the index.  He then proportions a reasonable fee for the index fund management based on the Vanguard S&P 500 Index Fund (0.18%) to find out the true cost of the actively managed portion of the fund.  That is, he assumes that the indexing investment management cost 0.18% for the portion of the fund managed this way, with the remaining management cost being attributed to the actively managed portion of the fund.  The results are very interesting.  For the 152 'large company' mutual funds that formed the sample, on average only 15.55% of the total funds were actively managed.  (ie the other 84.45% effectively mirrored the index return).  The average management expense ratio (MER) for the actively managed portion of the funds was 6.99%.  On average more than 96% of the variance in the returns of the fund was explained by movements in the index.  On average the 'value added' by the active management was negative 9%.  This is an investment loss of 2% on top of the fees of 6.99% apportioned to the actively managed component of the fund, clearly demonstrating that in this sample active management destroyed value.


On an overall basis the 152 mutual funds underperformed the index by an average of 1.5%.




Earlier in the chapter we looked at the research costs borne by investors and the market impact costs of investing through an actively managed fund.  It stands to reason that any active investment process will incur  higher level of fees as the underlying investment manager is really selling you their expertise. 


This expertise might be 'sold' to you in the form of the fees paid on a managed fund, the fees paid for a portfolio management service or the fees paid to a financial planner.


These fees add up, and it is not uncommon to find people paying in excess of 2% of the value of their portfolio in fees.  In fact, most active managed funds charge fees of around 1.8% to 2% per year.


Somehow a 2% fee doesn't sound too expensive.  However, a $4,000 annual fee on a portfolio valued at $200,000 starts to add up very quickly. 


Assessing fees in the world of active management is difficult, because of the assumption that the fund manager, portfolio manager or research company that you have chosen will outperform the market anyway.  If they can do better than average, then why worry about fees?  Once the reality that they cannot outperform sinks in, then the level of fees that have been paid becomes a very sad lesson.


Whereas the average fees for a managed fund are 1.8% to 2%, the fees on an index fund start at around 0.7%.  This level of fee is still higher than in the United States, where fees start at around 0.18%, and it is hoped that over time as the Australian index fund market matures and becomes less expensive the level of fees charged will fall.


Lower fees in index and passive funds are a function of the lack of research needed to run index or passive funds.  Simply holding all the investments in a market, in the proportion that they exist in the market, requires little research, ongoing monitoring or advanced decision making.




How Do We Apply This?


We have looked at evidence that concludes that index and passive investing are effective.  This chapter presents the reasons behind that effectiveness.


These reasons lie at the core of the success of index and passive investing.  They are part of the compelling evidence for building investment portfolios using this approach.


Index and Passive funds are not only effective but inexpensive, extremely well diversified and tax effective.  It is no wonder that they form the basis of our investment approach!


For more information on this approach please take a look at our Building Portfolios page on our website.

Posted by: Scott Keefer AT 09:40 pm   |  Permalink   |  Email
Wednesday, November 05 2008

In his latest article written for Alan Kohler's Eureka Report, Scott discusses Warren Buffett's recently released official biography - The Snowball.

Scott takes away 5 key factors emerging from Buffett's disciplined approach to investing:

1) He is an exceptionally intelligent investor
2) His use of the margin of safety
3) He is a dedicated entrepreneur
4) He uses minimum borrowings
5) The snowball effect

Click on the following link to read Scott's analysis - Warren Buffett's textbook on investing ... and life.

Posted by: AT 10:07 am   |  Permalink   |  Email
Monday, November 03 2008

A natural reaction of late, especially since the strong falls on share markets across the world through October, has been a flight to safety namely cash.  The Australian government guarantee of cash deposits has solidified at least one area of the market.  This looks pretty attractive when most other asset values, even residential property based on data out today, are falling or have already fallen significantly.


Unfortunately, interest rates on these cash deposits are also falling.  Central banks around the world (whole heartedly supported by their respective governments) have cut interest rates in what has been viewed as a coordinated response to the looming downturn in the global economy. (Some would say slashed but I think emotive language such as this coming out of the media has been less than helpful and is in a small degree responsible for the scale of the falls on markets.  I'll get off my soap box now.)


The economic theory behind these moves is that through reducing interest rates, access to credit becomes more accessible and at the same time fewer resources are needed to pay back outstanding debt.  This in turn leads to more money being freed up by and for consumers and companies to spend in the real economy.  This in turn leads to higher levels of economic growth.  The economic term to explain this policy move is loosening monetary policy.  The sooner this is done the better as economic theory suggests the time lag between a cut in interest rates and for this to lead to a stimulation of the economy can be up to 18 months in duration.  Let's hope the impacts are felt sooner rather than later!!


These reductions in interest rates flow on to the rates paid by institutions for customers to loan them money by depositing their money with the bank or other financial institution.  These rates paid by banks and the like in Australia are still comparatively high compared to other developed parts of the world, thinking particularly of Japan and the USA, but are starting to fall.


As rates fall it makes the decision to hold cash that touch more difficult.   In a Eureka Report article published early in October - Yields the new king? - Scott Francis pointed out that the yields (or income) on Australian shares and listed property trusts are making these asset classes look a whole lot more attractive compared to cash deposit interest rates, especially when taking into consideration franking credit benefits. 


Nicole Pedersen-McKinnon provided a similar angle in her article published in the Sydney Morning Herald and dated the 26th of October - Cash is safe but it isn't king - where she in particular referred to the dividend yields of 8% or more being offered by the big four banks.  The big assumption here is that company dividend payments will at least remain steady.  There is some doubt as to this but so far the big banks, the part of the market which has suffered the most from the credit crisis so far, have at worst maintained dividends (ANZ) or in other cases continued to increase.  What this is telling investors is that if you buy shares in the banks now and held them like holding a term deposit, the income returns - the money coming into your bank account - would be 8% compared to what could soon be 6% or even in the 5% range for cash deposits after a few more RBA cuts.


Now of course the growth side of owning shares, taking the big 4 banks as an example, have been anything but stellar over the past 12 months.  If you might need to access the capital contained in a bank account or a share investments there is real risk in buying shares as the underlying investment may still fall in value.  But if you have a buy and hold strategy, for the long term, you would have to think that asset prices are pretty compelling at present levels.


A third piece of commentary on the problem with holding cash over the long terms is that inflation is a killer and eats into the returns from cash.  Warren Buffett makes this case in his article - Buy American.  I am. - which I have referred to in a previous blog posting.  Growth assets, such as shares, also have a growth component and their income tends to grow over time, both providing a hedge against the impact of inflation.


As Nicole Pedersen-McKinnon suggests in the conclusion to her article - buying bank shares (or any shares) is not for the faint hearted but dipping the toes in and taking a conservative, measured approach through techniques such as dollar cost averaging might make some sense.  However in my view this should only be contemplated by buy and hold long term investors in consultation with their financial advisor and in relations to their current portfolio allocations, as the share market might just keep falling in value and/or dividends might not hold up over the coming year.



Scott Keefer

Posted by: Scott Keefer AT 05:23 am   |  Permalink   |  Email
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