Can you afford to not DIY invest

Grant Thornton has completed some research (free FT link or Google “How much do you really pay your money manager?”) which concludes that someone entrusting £100,000 for 10 years to a UK financial adviser or investment manager would pay an average 2.56% annually for financial planning services and financial product expenses.  Let’s look at what that might mean during both the wealth accumulation and drawdown (assuming no annuity is purchased) phases of a typical investor.

Wealth accumulation phase

When it comes to investment return, excluding expenses, I believe that active investing is a zero sum game resulting in average performance no better than that of the market average.  Of course there will be some winners and some losers, particularly in the short term, but that’s for another day.  Today let’s therefore assume that the investment return these money managers achieve is that of the market.  Let’s look at a couple of possible portfolios.

Unfortunately, the Vanguard LifeStrategy funds have only been around 5 years or so which isn’t enough time to use for this study as I need 10 years (or so) of data.  Vanguard does however have an interesting Asset class risk tool (h/t diy investor (uk))which allows you to input a period and an asset allocation.  Let’s create a reasonably balanced portfolio with 60% stocks, 35% bonds and 5% cash and run for a period of 10 years.

Click to enlarge, 10 year time frame, 60% stocks (FTSE UK All Share Total Return Index), 35% bonds (FTSE British Govt. Fixed All Stocks Total Return Index (1983 - 2013) and BarCap Sterling Aggregate Total Return Index), 5% cash (LIBOR 3-month average over the year)

The result is an average annual investment return of 5.59%.  So with this return what does our investor have left after a few subtractions.  Firstly, let’s subtract the erosion caused by inflation.  The RPI has averaged 2.87% over the last 10 years.  Subtracting that gives us a real return of 2.72%.  Now let our money manager and the investment products s/he is peddling take their cut of 2.56%.  Oops our real return is now 0.16%.  Looking at it another way our average money manager/investment product provider is taking 94% of our real return, leaving us with 6% only, which is hardly conducive to long term wealth building.  It also gets worse as that will be before portfolio turnover costs, taxes and trading costs to name but three.  After those we’ve probably nearly done no better, or maybe even worse, than matching inflation which might mean we’re actually even going backwards.

I do however hear readers gnashing their teeth and shouting that the portfolio chosen is not diversified enough because it includes no international equities, emerging market equities, property, commodities, corporate bonds...  Let’s do that by now using my portfolio.  I’ve only been at this game for 8.9 years and so only have data for that period.  It is however long enough to have invested through a bust (the global financial crisis) and the subsequent boom.  To date my investment return, after expenses and withholding taxes, has been 6.85%.  Over the course of my journey expenses have probably averaged 0.4% (they were already down to 0.59% in November 2009 and were 0.25% last weekend).  It’s a bit of a guesstimate but let’s add 0.1% for withholding taxes.  Summing those gives an average annual investment return of 7.35%.  As before let’s now remove inflation and money manager/investment product expenses leaving us with a real 1.90% investment return for ourselves.  It’s a little better but in this scenario we’re still losing 57% of our real return to our money manager/expenses.

Wealth drawdown phase (assuming no annuity is purchased)

So our average money manager and investment product provider is making it real tough to build wealth.  Let’s now look at how much wealth we actually have to build if we want to keep his/her help through our retirement.  Wade Pfau tells us that if history repeats with a 50% global stocks : 50% global bonds portfolio, with a 30 year investing horizon and inflation linking our spending, the maximum we can extract from our portfolio per annum is a starting 3.26% before investing expenses.

Firstly, let’s look at my DIY approach and assume a desired starting spend of £25,000.  As mentioned above my investing expenses are currently running to 0.25%.  So under our 30 years retirement scenario I would need wealth of £25,000 / (3.26%-0.25%) = £830,565.

Now let’s get help from our average money manager and investment product provider.  In this scenario I now need £25,000 / (3.26%-2.56%) = £3,571,429.  That’s quite a difference.

Stepping into the DIY investing world is not without risk.  My experience suggests that you do need to educate yourself and even with that you will still make some mistakes.  There is also of course the risk that you might lose it all.  The question I’m asking myself though after thinking through the ramifications of the Grant Thornton study is can you afford not to DIY invest?

As always DYOR.