I’m of the opinion that you should never outsource your financial health because most people are getting screwed. You work so hard for your money and may not fully understand best practices when it comes to investing. It’s no help that the industry overcomplicates this and is far from transparent. It’s a damn shame. There are a bunch of common ways people are getting screwed and ways to avoid it.
Mutual Funds
If you walk into a bank with some money to invest, they're likely going to sell you a mutual fund. These things have horrendous fees, and very little upside, unless you are the fund manager who gets rich.
How bad is it?
Universally these are very common investments for the average person. Canada is in a particularly poor spot here with 1.7 Trillion dollars invested in mutual funds in 2020. The average mutual fund fee in Canada is also particularly high at 2.3%.
These funds are typically just a mix of equities and bonds and don’t tend to have particularly good performance. The average person can pick a couple ETFs and get better performance.
The historical return of a 60/40 portfolio (60% equities, 40% bonds) is something like 7%. If you paid a 2.3% fee for a mutual fund your returns are clearly reduced.
$100k invested over 10 years:
Return from mutual fund with 2.3% fees:
$100,000 * 1.(07 - .023)^10 = $158,294
Returns from 60/40 portfolio with no fees:
$100,000 * 1.07^10 = $196,717
That’s a difference of $38,423
And this gets worse over time due to the magic of exponential growth and compound interest:
$100k invested over 50 years:
Returns from mutual fund with 2.3% fees:
$100,000 * 1.(07 - .023)^50 = $993,880
Returns from 60/40 portfolio with no fees:
$100,000 * 1.07^50 = $2,945,702
Over 50 years the mutual fund cost 2 million dollars out of your pocket.
How to avoid this?
If you're going to get a financial coach or planner or get investment advice, hire someone that gets paid on some kind of subscription basis. Avoid anyone or any service that gets paid on commission of the funds they sell you. Look out for funds with high fees. . If you hire a financial coach at an average $1k a year, over 50 years that will cost you $50k instead of 2 million dollars.
Examples of types of financial advice I believe are worth considering:
Facet Wealth (US based fixed fee not a percentage of assets)
New School of Finance (Canada based pay for sessions)
Wealthsimple (0.4%-0.5% fee, low enough to consider)
If they aren’t forthcoming on their fees / fund fees or avoid answering questions about cost, you may want to look elsewhere.
Owning the Wrong Index
Index investing tends to outperform individual stock picking because money and the stock market follow a power law. Which essentially means a small percentage of stocks determine the overall outcome of the market. This is the opposite of a lot of other things in life. If the average North American male height is somewhere around 5ft 9inches most folks are closely within that bound, i.e., you won’t find someone 100ft tall. However, you will find companies that 1000x outperform other companies. This phenomenon means the average is determined by the outliers, and the average return is greater than the median return.
Average North American male height: 5ft 9inch
Median North American male height: 5ft 9 inch
Avg S&P 500 stock market return: 6.1%
Median S&P 500 stock market return: 2%
So you will underperform if you don’t own the outliers, one way to ensure you own the outliers is to buy everything (i.e. index investing).
Unfortunately, there are a lot of indexes and it’s easy to be a ‘passive index investor’ and still miss tons of performance driving outliers.
Outliers that have been easy to miss
Silicon Valley Tech Industry
Living outside of the US and not owning US indexes. The Silicon Valley Tech industry has been the big outlier over the past 20 years, and is why the Nasdaq has performed so well.
10 year Canadian Index return (TSX Composite): ~1.68x
10 Year European Index returns(STOXX Europe 600): ~1.98x
10 year US Index returns (S&P 500): ~3.61x
10 Year Nasdaq returns: ~6.34x
10 year Amazon returns: ~14.25x
Cryptocurrencies
10 year Bitcoin return 680771x
When in doubt, own a little bit of everything to increase the chances of hitting an outlier. You can boost performance even higher by correctly predicting outlier markets or companies, but most people fail at that.
How to avoid this?
Own US Indexes
Default to optimism: own a bunch of things where some fail rather than miss owning the outliers
Consider allocating something toward crypto indexes
‘Risk Averse’ Bond Allocations
20 years ago government bonds yielded something like 6% and Consumer Price Index (CPI) rates we’re something like 2.5%. So holding a government bond was a risk free return of 3.5%. just Free money from the government for doing literally nothing. Nowadays bonds yield something like 1.5% and the CPI rate is sitting at 5.4%. So money sitting in bonds is melting at -3.9% (5.4-1.5) a year in value when it comes to buying goods. Even if this is transitory and the inflation rate gets down to 2% bonds are scary.
Yet most folks are still following traditional asset allocation strategies that basically amount to 100 - your age in stocks and the rest in bonds. So if you we’re 30 you would have 70% equities and 30% bonds.
Things that I would rather put in a portfolio in some diversified mix to replace or complement bonds. These are fixed or limited supply assets.
Gold
Real Estate
Cryptocurrencies (small percent highly volatile)
Art (https://www.masterworks.io/)
Wine (https://www.vinovest.co/)
Collectables (MTG cards, Hermes bags, Rolex watch, etc)
How to avoid this?
Consider allocating towards alternative assets (not just stocks or bonds). Talk to a financial planner that works for you (not just mutual fund fees).
Disclaimer: This does not constitute financial, investment, tax, legal or accounting advice nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this article should consult with his or her advisor.