Don’t get ripped off by financial services insiders

I’m now in an Internet cafe surrounded by beautiful Thai girls and a couple of Thai boys all chatting online with their foreign “men-friends”. Most girls (and boys) will have several men-friends all sending them money because “you no send money, me hab work bar”. One girl has a book, which sells quite well here, giving useful phrases to use when emailing and chatting to foreign (farang) men-friends. I keep hearing “me lub you” and “me miss you” and “you come Thailand soon” and “mama sick, you send money for doctor”.

Anyway, let’s get back to the financial services rip-off merchants: here are four simple ways to avoid being suckered.

1. Look at the difference between risk-free return and what’s being touted – the most common mistake made by savers is to be seduced into handing over their money by suggestions they can get returns of 4% or 5% or 6% a year – enticingly more than they would get from a bank. But what most savers fail to do is to factor in how much risk they are taking for relatively little extra return. You can get about 3.5% completely risk-free fron a 2-year fixed-interest bond. So if you’re attracted by say a potential 5% from a unit trust, you’re actually taking quite a lot of risk (and paying a lot in charges), not for 5%, but just for the 1.5% difference between the hoped-for 5% and the 3.5% you can get risk-free. In most cases, it’s not worth taking the extra risk and paying the charges for so little extra. 

2. Work out the real costs – normally you’ll pay much more for savings products (unit trusts, pensions etc) than you’re led to believe by those selling them. For example, a unit trust may claim their management charge is only 1.5% a year. But you also lose about 5% when you buy in and another 5% when you take your money out. You’ll also pay at least 0.5% a year above the management charge as it doesn’t include costs that are in the TER (Total Expense Ratio). And you’ll pay at least another 0.5% a year in dealing costs which are not included in the TER. So if you keep your unit trust for five years, you lose 5% going in, 5% coming out and 2.5% a year in charges – in total 22.5% of your money.

Had you put your money in a series of 2-year fixed-interest bonds, you’d have about 18% growth (before tax) over 5 years. So, to beat your bond, your unit trust would have to grow by more than 40.5% over the 5 years (the 18% you get risk free plus the 22.5% in unit trust charges). The minimum your unit trust would have to achieve would be over 8% a year to make it worthwhile – that’s not going to happen. 

3. Do it yourself – Once you’ve accepted that the people making the real money are financial services insiders manipulating markets and the huge costly chain of advisers, fund managers, lawyers and others siphoning off their cut of your money, then you can invest like a realist and not like a fool. As far as I can see, there’s only one way to make a little money in financial markets. Either with shares or pensions, look at the sales blurb of a few unit trusts, see what are the main shares they hold and then buy a few of those shares yourself either directly or through your SIPP. Ideally, those shares should be regular dividend payers and you should reinvest the dividends to buy more shares in the same companies.

4. Only buy in the dips – This is the most frustrating and difficult aspect of saving. When shares go up, all the financial journalists and advisers and salespeople are shrieking at us to buy, buy, buy! But the opposite is true – when share prices are high, you should never buy. You should only buy when they are low. Stock markets do not go up over the long term. They fluctuate around an average level. If you buy when they’re below the average, you’re likely to make money. If you buy when they’re above the average level, you’ll probably lose. Remember, the FTSE was once at 7000, now it’s around 5800. There are very few people who have the courage to buy when prices are falling or low and the courage to sell when prices are rising or high. If you’re not absolutely convinced that you are one of this tiny group, then shares and unit trusts and SIPPs are not for you.