Wednesday, October 24, 2018

Beat the Bank

It can be frustratingly difficult to get the masses to understand how important it is to control investment costs. Ex-banker Larry Bates does an excellent job of explaining what he calls Simply Successful Investing in his book Beat the Bank. Canadians who hand their savings over financial advisors at banks or elsewhere need to read this book.

Bates knows that people don’t want to become investing experts. “There are countless things about investing you don’t need to know: this book focuses on the few things you do need to know.” You don’t have to “listen to the daily tsunami of utterly useless media chatter about the financial markets.”

As a career banker, Bates understands the harm that bank mutual funds do to people’s savings. This harm became personal after a conversation with his sister. He was left embarrassed and ashamed after learning that she was taken in by his employer’s high-fee mutual funds. “Fees are stealth wealth killers.”

The book refers to “top banks, insurers, and mutual fund companies” as Bay Street, the downtown Toronto street where many of these companies are headquartered. “Bay street fees continue to quietly strip away 50 percent or more of the lifetime investment gains of millions of Canadians.” When I tell people this, they typically react with disbelief. Maybe they’ll believe it coming from a former banker.

Bates has a web site where you can get your “T-Rex score,” which is a measure of “how much of your investment return you will actually get to keep.” T-Rex is short for Total Return Efficiency Index. The catch is that you have to know what you pay in annual fees to get your T-Rex score. This is a challenge for the blissfully-ignorant investors who think they don’t pay any fees.

The book lists the T-Rex scores for many of the biggest mutual funds in Canada. The average score is a pathetic 45%. The missing 55% is what Bates calls “true fees.” “Freedom 55? I think not. More like 55 percent of your money is gone.”

The biggest mutual fund providers don’t care which of their funds you invest in, as long as they get your money. That’s why they “operate hundreds of mutual funds at any given point in time. This means the big players will almost certainly have at least some four-star and five-star ranked funds.” This is true even if the good results in a few funds are just blind luck.

According to Burton Malkiel, “A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by experts.” Bates continues with the monkeys asking us to “imagine a mutual fund provider named Simian Fundco employs eight monkey to select stocks.” After a year, four outperform. After another year, two outperform again. After three years, one monkey has outperformed three straight years. This monkey “is anointed as Simian’s new star.” No actual skill is required to advertise a star money manager.

In a call for action, the reader is asked to “Choose One: 1. Make Bay Street Rich 2. Make Yourself Rich.” Unfortunately, most Canadian investors have unwittingly chosen option 1.

To entice readers to learn a little about investing, he distinguishes between a do-it-yourself (DIY) investor and an assemble-it-yourself (AIY) investor. DIY investors devote much of their time to following individual stocks and reading annual reports. AIY investors just choose some low-cost index funds and ignore their portfolios most of the time. The book gives examples of good index funds for building a complete AIY portfolio. By these definitions, I was a DIY investor for a while; I had a good year followed by a bad decade. Now I’m a happy AIY investor.

One barrier to becoming an AIY investor is the fear of doing something wrong when making online trades with a discount broker. Even though I’ve been doing this for almost two decades, it still makes me nervous to make 5- or 6-figure trades. I wasn’t aware that most discount brokers have practice accounts “to get familiar with buying and selling processes before you consider doing the real thing.” This sounds like a great idea to dispel fear of the unknown.

For those who still find AIY investing more than they want to take on, robo-advisors are an option that Bates includes in his definition of Simply Successful Investing. Robo-advisor fees are higher than teh MERs of low-cost index funds, but they are still far lower than typical Canadian mutual fund fees.

In a discussion of DIY investing (stock-picking), Bates tries to put stocks into categories: Blue Chip, Moderate Risk, and Speculative. However, these categories are illusory, as the author later admits. Any stock can fall to speculative status before you figure out you should sell. Nortel “is a particularly prominent and painful Canadian example.” Bates credits stock-pickers with near 100% T-Rex scores, but invisible losses from competing with pros on stock selection make stock-picking a bad choice for most investors.

“Long-term business ownership through the stock market is a bet on the continued ingenuity, dynamism, growth, and prosperity of today’s North American businesses and tomorrow’s budding entrepreneurs.” It pays to be optimistic about the future as long as you protect yourself adequately from short-term paper losses. “Today’s bonds are virtually useless at building wealth,” but they “can be highly effective at protecting wealth.”

“Canadians love ‘balanced’ mutual funds.” However, the fees are stripping away almost all of the bond returns as well as too much of the stock returns. “High-fee balanced mutual funds are conveniently lucrative for Old Bay Street and simply awful for investors.”

You’re better off being a bank owner than a customer. “If you think Bay Street banks overcharge, earn enormous profits, are protected by the government, generally get away with murder, and will continue to do so, there is a perfect way for you to address the ‘inequity.’ Include bank stocks in your portfolio. Make bank profits work for you.” This is good advice to a point, but don’t miss the book’s message about diversification. Unfortunately, many Canadians have portfolios dangerously concentrated in Canadian bank stocks.

One piece of advice I don’t agree with is to make trades at the market price. Limit orders are safer. Just pick a price a few cents worse than the current bid or ask. So, if the market says you can buy at $20, you can set a limit of $20.05. If all goes smoothly, you’ll get the $20 price. If the market price happens to run away at that moment, you’ll pay at most $20.05 per share or trade won’t execute. In addition to protecting you from major market movements, limit orders help you avoid spending more than the amount of cash you have in your account.

Among the investments Bates thinks you can safely ignore are gold, preferred shares, corporate bonds, and Bitcoin. Sounds sensible to me.

A nitpick is the two quotes about compound interest attributed to Albert Einstein. Fact checker Snopes finds this attribution “dubious” because “Einstein died in 1955, but the earliest mention we could find of this item was in a 1983 New York Times blurb.”

This book delivers on its promise to stick to the few things you need to know about investing. I highly recommend it for any Canadian who has or expects to have enough savings to invest.

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