October 24, 2004

Ripping off the punter

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Next week thousands of people will have to square up with the Revenue as the tax deadline for the self-employed looms.
This period is a boon for advisers as all sorts of self-employed workers try to minimise this year’s tax bill by setting aside income for future pensions.

To grab some of this lucrative action, financial advisers – from the small one-man-and-his-dog brokers to the large investment banking arms of our financial giants – have been in snake-oil mood, promising vast riches and wealth through a variety of products, funds, stocks and bonds.

Who are these “expert” professionals and what do they charge for looking after your shekels?

Well, the first thing of note is that the financial industry is paying itself handsomely for handling your money. Go to any expensive restaurant in Dublin at lunchtime, get any business class flight out of Dublin airport, check into any five-star hotel anywhere in the world and you will see them.

The young men in smart suits and swanky ties, who work in the financial services industry and pore over biased company research on red-eye flights, are busily spending your money. And my God, do they spend.

As a poacher-turned-gamekeeper, I have a bit of knowledge of this game. Back in the London of the early 1990s when I first worked in the industry, I was amazed at my own starting salary in comparison to my friends.

On top of this were bonuses that ran into multiples of the average industrial wage. This was before the premium class flights, five-star exclusive hotels, open-ended credit cards and huge expense accounts.

Who paid for all this? You did. The investor, the pension holder and the life assurance policy holder forked out millions of pounds daily to keep these people in clover. That was back in the bull market and yet today in Ireland, we have fund managers still taking fees for losing their clients’ money.

Warren Buffett, the world’s finest investor, calls the excessive fees in the financial industry the “croupier’s take”, likening the investment markets to a casino.

The croupier takes from the client on three levels. First, the brokers need to be paid. Second, the fund manager takes his cut and third, listed companies have to be managed.

Let’s assume that the stock market will return 5 per cent a year on average over the next decade. How much of that 5 per cent will the average investor see?

Five per cent per year may well be too optimistic, but this is the figure many commentators appear to expect on average per annum.

Last January, the Iseq index traded around the 5,300 mark, while today it is at 5,637 – and therefore the market is up about 5.9 per cent so far.

On average, managed funds charge a 0.5 per cent annual fee for administration and the like.

Quite what administration there is in a tracker or passively managed fund, I can’t figure out. Surely, one letter a year and a bit of basic housekeeping does not cost 0.5 per cent of the principal, but there you go.

In addition, there is the commission from trading stocks on top of the spread between bid and offer price, which is trousered by the brokers in the industry.

On average this is about 1 to 1.5 per cent of the transaction. Already, the investor is down to a little less than 3.5 per cent of the likely 5 per cent increase in stock prices.

Before you can be sure of your 3.5 per cent return, what about the up-front costs?

If you take out a retail fund today, you are likely to pay a signing-on fee. This varies from 3 to 6 per cent, but is typically about 5 per cent.

Given that we are all advised to stay in for the long haul, it is fair to suggest 1 per cent per year. The state also gets in on the act here with a 1 per cent stamp duty charged on each transaction. Therefore, the punter is down to 1.5 per cent return.

Remember that the rate of inflation is running at around 4 per cent.

Finally, what about the managers of the listed companies themselves? They need their shekels too, typically by way of stock options. Although Irish executives may not be involved in this racket quite as much as their US counterparts, they take their cut.

Following the advice of financial market experts, US senior executives trouser 20 per cent of the increase in stock price by way of cut-price preferential options, according to Standard & Poor’s.

So there goes one dollar in every five for the investor.

Given the huge fees that corporate advisers generate for mergers and tactical financial advice, the industry reckons that about half a per cent of any upside in a deal goes straight to the investment banker.

That’s another 1.5 per cent taken off the pension holder’s return. Amazingly, the investor is left with nothing or next to nothing, based on the prediction that stock markets will rise by 5 per cent per year, as is the base case for most funds.

There is also a self-reinforcing problem here. The smaller the return, the less cash will go into the market, forcing the return down again. Given the fee structure, investors will be getting negative returns for some time to come.

Obviously, we can tweak the numbers here and there a bit. However, the message is clear. Investing in a defined contribution pension in the stock market is not worth it because the financial industry takes all the upside to pay itself handsomely for doing sweet Fanny Adams.

I suppose someone has to pay for all those Reuters screens, boardrooms and lovely views from the IFSC over Howth, Dublin Bay and the Dublin Mountains.

And, in the absence of a significant bull market in stocks, the punter is getting shafted.

Even in a bull market, which is highly unlikely to come about again for quite some time, the croupier takes an excessive cut.

The bloated financial services industry needs a reality check. We pay its bills. The industry operates as a middleman, channelling national savings from your pay slip to selected companies via the stock market. When you cut through all the glossy research, fancy boardrooms and marble foyers, that’s all it is: a handler of savings.

There is no alchemy.

Yet as an industry it is one of the greatest recipients of state subsidies through the tax breaks that go with pensions. It is, therefore, the 21st century industrial equivalent of Irish Steel – a large sheltered, bloated industry existing and profiting from tax breaks.

This raises the question: where is the industry going? Ryanair is a good model.

There is now a great opportunity for a Ryanair-type outfit to come in and grab the industry by the scruff of the neck, offering the lowest prices, best deals and a decent basic product.

Until then, beware the snake-oil salesmen, their benchmarks, complicated charts and relative-value spiels.


  1. David Burke

    I agree David. I fell victim to this type of larceny and
    lost thousands on a pension. I now strongly recommend
    people to avoid pensions at all costs. I consider myself
    intelligent and well educated and I worked in the finical
    services industry for about 20 years. In fact I have
    actually worked with the mathematics of some of
    these “products” (scams) .

    How did I fall victim to the Irish financial services
    industry ?, (it’s not actually an industry in the true
    meaning of the term, it’s just a vehicle for common
    thievery).

    In my case it was pure laziness. Although I blame myself,
    I feel that it is almost impossible not to be suckered by
    the Government/Irish financial services industry. I was
    wary and careful but still, my money was stolen.
    Advertisements are telling you to get a pension and there’s
    a natural pressure to do something for ones old age, I just
    succumbed and paid over.

    In the short term I felt good as I thought I had done my
    duty, but lets be honest I was just a sucker.

    As for the Irish financial services industry’s mumbo jumbo,
    their benchmarks, complicated charts and relative-value
    spiels, Richard Feynman said “If you cannot explain
    something to your target audience then you don’t understand
    it yourself ”.

    David, I’d give my right arm to work for “a Ryanair-type
    outfit to come in and grab the industry by the scruff of
    the neck, offering the lowest prices, best deals and a
    decent basic product”. So if such an organisation should
    be created, call me, I’m very experienced , good value and
    hard working, I’m willing to make a personal investment in
    changing the system.

  2. Gerard

    Instead of waiting for a Ryanair/Yellow Pack outfit to come
    to the market why do you not recommend the fund managers
    you use yourself. That is, if you have a pension fund?

  3. David Mc Williams

    Hi Gerard, with regard to who manages my pension. i try as
    best i can to do it myself. You might be interested in a
    group called ICES who are meeting tonight in the Alexander
    Hotel in Dublin. They are normal people who are trying to
    take control of their own finances and make small
    investments for themselves. Well worth the trek. Regards,
    David

  4. Fintan

    Like the saying goes:

    “Which yachts belong to your customers?”

  5. John

    I’m a Life & Pension Broker working for my own company and
    clients. I’ll explain a little of the current story.

    Pensions and other investments are sold not bought by the
    general public. A good example of this is the slow sales of
    standard PRSAs(Personal Retirement Svings Account)which are
    limited in charges. PRSAs are an excellent pension product
    when advised properly, however most advisers are of the
    opinion that with the increased compliace required that
    they are not profitable sales. All of the PRSAs I have sold
    have shown a profit for my clients within the first year
    and I’m satisfied that my clients are happy.

    If you want a good pension you’ve got to pay up for it and
    I don’t mean commission. The general public is not aware
    that 15% of salary is a good yardstick for an annual
    contribution that will provide a reasonable pension at
    retirement. Self-Directed pensions are another pension
    vehicle gaining popularity as you can nominate your own
    holdings and maintain a portfolio of investments beyond
    retirement.

    When I read newspaper stories about commission I get
    annoyed as it is generally a negative connotation however
    their is never a mention of how one otherwise should get
    paid as most clients would rather not pay fees. I’m of the
    opinion that a 5% charge on entry and an annual maanagement
    charge of 1-1.5% on a good performing pension fund is not a
    ripoff however I’m not an economist and I await your ideas
    on renumeration as no doubt you like to get paid also.

  6. brendan

    i’ve only discovered this site today, its a gem among a
    desert of pebbles.

    david, you talk about the irish obsession with property but
    given the state of the financial services industry you can
    understand why so many people are investing in
    houses/apartments as a pension.

    by the way, i miss your show on newstalk. i always laugh
    when dunphy struggles over words like ‘ISEQ index’
    and ‘euro/dollar exchange rate’!!!

  7. ronnie

    agree with you david, i see dealers and brokers doing
    little and getting great junkets,free hospitality in croker
    etc,its just an extra layer of cost thats borne by
    consumers ultimately.why dont you post the best products on
    your website david? untill people are properly educated
    about personal finance these companies will rake it in for
    underperforming the market.your better buying the market in
    the form of a security like the nasdaq which is quoted as a
    security on the new york or dow symbol qqq -you get the
    diversification and growth(assumed 5%) without the fees,why
    isnt this done on iseq and ftse?

  8. Joe Gleeson

    David, I came across this article when Googling. Looks like you were a bit pessimistic about the stock markets, (ISEQ up 40+% , china up god knows how much!). However your point on the greedy investment sharks still rings true. For example the SSIA scheme was good, but for equity investment one HAD to use these so called “Fund Managers”. As you well know their is precious little management needed in the Index Tracking funds used by (for example) ILP in their SAVERSCOPE scheme. (5% bid/spread, 1.5 % annual charges).(ie. to mimic CELTICSCOPE just pick the top 5 Irish Banks and CRH and buy shares in each based on their relative sizes on the market, e.g 16%(AIB), 14%(CRH),13%.(BOI)…) I also started an AVC recently. The charges seem small (1% per annum), but after twenty years that will amount to a lot of money given to pay for the investment managers lifestyles. Also this is ‘Guaranteed’ money for them” even if they sat back and did no analysis/management of fund. I have a sneaking suspicion that most pension funds nowadays use asset tracking that involves no real work.The ‘Only’ reason I started an AVC was to avail of the tax breaks on pensions. Otherwise I would have just bought/sold my own shares and built up a retirement fund. When times turn bad their could still be a number of ‘nasty surprises ‘ for people in their investments. With little or no management funds might just waste away.

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