Is the return calculation really that simple? These are theoretical returns. What about….
Stocks/funds you pick Your strategies Timing of your trades Skill Published indices Dividends Survivorship bias Returns Annual fund charges Commissions to intermediaries Bid/offer spread Trading commissions ‘Price impact’ Broker account fees IFA fees Stamp Duty Tax on dividends Capital gains tax Costs
Monkeywithapin = the random stock picking entry in the UK Stock Challenge competition 2011 – Monkey in top 10% 2012 – Monkey in top 10%
Ola the Chimp Competition over a month with 5 pro traders. Ola’s gains X4 best other pro!
Wall Street Journal Competition 147 monthly competitions between 1990-2002 The competition: – Top 4 Wall Street pros each picked a stock vs – Editorial staff threw darts into the paper Results assessed after 6 months
Source: E.Porter, Journal of Applied Finance (2004)
Disappearing funds In the UK, the fund industry closes 10% of failing funds each year Beware: Fund stats only show successful ones! Estimated effect = -1% pa Source: Rohleder, Scholz, Wilkens, Review of Finance (2011)
Effects of survivorship bias on indices I can’t find any definitive work on it (idea for a dissertation??) However not using complete datasets has a massive impact on financial models Source: Frank Hassler – http://engineering-returns.com
Factors reducing investors returns Investors in shares directly Investors in funds directly Skill/alpha of the investor–1.3%–2.2% Skill/alpha of a fund managern/a+0.2% Index error due to survivorship bias–1.0%
Q. What is the average size of your trades? £250 (or less) £500 £1000 £++more
Fund Charges Annual fees (TER): 1.7% – Can be less on passive funds – Can be a lot more! Bid/offer spread: 5% – Can often be much less* Distribution levy: small * For my calculations, I have assumed an average 2.5% spread amortised over 5 years i.e. 0.5% pa.
The Hidden Costs TER (Total Expense Ratio) excludes: – Trading commissions – Stamp duty – Bid/offer spreads – Price impact Hidden costs are very dependent on Portfolio Turnover Rate (PTR). Assuming 60% PTR, hidden costs = 0.6%
Factors reducing investors returns Investors in shares directly Investors in funds directly Skill/alpha of the investor–1.3%–2.2% Skill/alpha of a fund managern/a+0.2% Index error due to survivorship bias–1.0% Trading commissions–2.5%–0.1% Stamp duty–0.5%–0.3% Bid/offer spreads–0.7%–0.1% Price impactn/a–0.1% Initial charge/distribution levyn/a–0.5% TERn/a–1.7% TOTAL–6.0%–5.8% -0.6%
Example: Endowment Policy 25 year policy from 1988-2013 Projected returns: >£48k Paid in: £17,250 Value now: £27,500 (4.2% growth) – But inflation averaged 3.5% – Stock market return of 9.2% Where is the missing 5%???
Cash would have better than share investing over the last 20 years
What might be future equity returns? Deutsche Bank predicting 0.6% above inflation (in the US) for the next decade Barclays Mortgage Dept now assume returns from Stock ISA investments over next 25 years will be: – Just the cash you pay in (not even inflation added)
What might be future cash returns? “Financial repression” will ensure: interest rates remain low (for as long as possible)
However don’t expect cash to out- perform in the future
Three tips to cut your costs 1.Trade less 2.Trade less 3.Trade less
Some other tips to cut your costs Pay no more than £10-£12 commissions Trade as large a size as possible Check bid/offer spread before buying Read small print charges and avoid any that charge annual fees, inactivity fees, etc Pick funds that have low annual charges and low initial charges/provide rebates Use funds for international exposure
What’s the best strategy? “Buy and hold will be poor option [over the next decade]”
Turtle Traders Richard Dennis bet William Eckhardt that anyone could be trained in 2 weeks to be a successful trader 2 of the 14 went on to earn $175m The secret: follow a system
Recognise that you need rules Determine some good rules Follow those rules The secret to successful investing