Yesterday I told you why you shouldn’t trust broker recommendations. Click here if you missed it. But it‘s not just the brokers that you need to be wary of in this industry.
The Murray inquiry has been in the papers all week. Its findings are making great follow up news to the recent Commonwealth Financial Planning fiasco — shedding some light on the system that allows such unethical behaviour.
The inquiry was carried out by former Commonwealth Bank CEO, David Murray — irony anyone?
But even though it was carried out by one of its own, the inquiry was quite revealing of Australia’s financial system.
The findings, which directly relate to investors and retirees, in a nutshell:
It found that as Australians retire they receive little advice on how they should manage their money and what investments are most suitable. The inquiry will consider rules to shift retirees into a default ‘investments’ option, encourage them to buy retirement income products, or even mandate that retirees own income products like annuities.
The inquiry recognises the need for non-conflicted and affordable financial advice. To improve clarity, they recommend that if agents receive compensation for recommending an investment product, this activity should be referred to as ‘sales’ or ‘product information’ rather than advice.
It recognises that the minimum standard of training and education of financial advisors needs to be raised and a public register of advisors be created.
Details of investment products need to be better communicated with investors. The current lengthy documents are confusing and fail to help consumers understand financial products and services.
Fees changed to manage superannuation are high due to limited competition. They see scope to reduce fees and improve after-fee returns. Introducing additional low fee options, like MySuper, plus a ban on borrowing to invest in super, were noted.
Let’s take a closer look at this last finding. And don’t underestimate the importance of fees. In the long run, fees have a massive impact on your retirement income.
Fees paid to manage your superannuation are not just high; they are double the amount paid in other Western countries.
That’s right. Australians pay TWICE as much in fees as other countries. And it’s costing us $20 billion dollars each year, or an average of $1100 on each account.
Consider that reducing fees by just 0.38% will add 7%, or $40,000, to the average member’s superannuation account at retirement. This 0.38% cut would save members a total of $7 billion each year.
Of course, fees shouldn’t be considered in isolation. Shifting your investments into lower cost funds will reduce returns. But you might be paying lower fees because your investment is receiving less attention or is in lower risk asset classes without the potential for higher returns. Comparisons should be made on after-fee returns for a given risk profile.
But putting risk profiles aside, do higher fee products provide higher returns?
An academic study in the US, carried out by the Squam Lake Working Group, has found this not to be the case. ‘High-fee funds argue that their fees are justified by superior performance. A large body of academic research challenges that argument. On average, high fees are simply a net drain to investors.’
So what then are we getting for these fees?
Well, not much it would seem. The Australian Prudential Regulation Authority (APRA) found that higher fee funds have not performed better. In fact, the lowest fee funds provide the best after-fee returns.
The real problem here is that funds don’t compete on price. There’s no pressure on funds to reduce operating costs or management fees. Instead Australian super funds, largely controlled by the big four banks, compete by creating (pricey) products with more features and options.
While the superannuation sector is now worth $1.8 trillion, lower fees haven’t been achieved through economies of scale or technology improvements either. Again, despite the size of the industry, it is dominated by a handful of players.
The lower fees found in other countries suggest that improvements can be made. But aside from legislation, it requires investors to use more discretion and take control of their investments, rather than trusting fund managers.
Take for example one particular super fund, which charges 1.08% per year to invest in ‘overseas shares’. In this case, ‘overseas shares’ means the MSCI ex-Australia Index.
But what if I told you that for just 0.42% you can buy a fund on the ASX that will match the returns of the same overseas share index?
That’s a saving of 0.66%, or $680 on every $10,000 you invest over ten years. You wouldn’t knock that back. Other than the price, the only difference in the two is that the super fund ‘aims to beat’ the index’s return, and has a better marketing budget.
You might assume that the extra cost will bring you better returns. But fund managers don’t have much success in outperforming the index. In fact, a staggering 88% of fund managers fail to beat the index they are paid to beat. Will you pay 0.66% extra for a manager who has a 12% chance of outperforming the index?
Don’t leave it to the industry to act in your best interests. Manage your own super. It’s not as hard as you may imagine, using diversified ETFs and managed funds, or following the recommendation of the Guild. If you have a ‘professionally’ managed super fund, don’t make extra contributions to it, especially if you are a long way from retirement. Avoid high cost investment products, uneducated advisors, or those with compensation misaligned with your interests.
You have to take action — read widely, educate yourself.
We’ll be back next week with more from the Guild. We’ll share our best investment ideas and tell you why you should invest some of your money outside Australia and how to do so. And Dan Denning will introduce you to our international board.
Have a good weekend.
Investment Director, Albert Park Investors Guild