The Man Who Ran S&P 500: "Ask Your Adviser This One Question!" The Hidden Fees Costing You £600,000

Alex, it's great to have you here. Thank you ever so much for taking time out of your schedule to chat with me. After our conversation last week, I thought it would be great to put some of the questions my customers are asking to you. First of all, could you give a quick introduction to yourself?

Sure. I'm retired now, but in my last job I was CEO of S&P Dow Jones Indices, where we own the S&P 500, the Dow Jones Industrial Average, and about a million indices that we calculated every night. They're used across the globe for ETFs, index funds, tracker funds, insurance products and benchmarking.

Prior to that, I was an index portfolio manager and trader, and earlier in my career I started out in the options industry as a buy-side options trader and portfolio manager. So I've seen indices and the broader wealth industry from a lot of different perspectives.

One of the things you mentioned to me last time was that you'd like to see more transparency in the financial industry. Where do you see the biggest need for it?

Transparency is always good, for anything. If you're hiding things, it's never good. And when you're dealing with people's wealth, it's always important to understand the interests of the providers of the services, the fees, the expenses, the performance, and the amount of risk you're taking.

That all falls into this broader idea that products should be more transparent. Unfortunately, in the investment business you have a lot of complex products and a lot of hidden fees. At the end of the day, investors have to make their own choices, either directly or through their advisor.

But you can't make an informed choice if you don't have all the information. That's why the concept of transparency really matters, whether it's an index and how the index works, or fee structures, or incentives. Incentives are a big issue: you have to wonder why someone is making this recommendation to me. What's in it for them?

And you mentioned performance. Not that long ago a lot of people didn't show the performance of their funds. I'm still seeing that now when I'm talking with people about their pensions. They've got no way to see how it's performed over the last year.

It's wild that this is still allowed, because, like you say, you want to know how you're doing.

It's hard, though. You have to think about performance at several levels. Typically you can find the performance of a particular fund, hopefully. That should be available.

Whether it's net of fees or gross of fees, at least it's something. It gives you some benchmark.

We have far fewer investors here than the US. We're savers. The government is trying to push at the moment to get more people investing, because it's mostly savers, and saving is mostly losing to inflation.

What would you say is the first thing people should think about when they're starting to invest?

I think people underinvest, typically. As you said, cash was historically seen as the safe asset. It's in the bank, so you know it's there.

The problem, as you pointed out, is inflation. Inflation eats at returns. I think 10-year gilts are somewhere around 10.7% right now, and I don't know the exact rate of inflation in the UK, but you could easily be losing two or 3% of that right off the bat to inflation.

Playing the long game helps you get through the question of whether the market is overvalued or undervalued today. On the timing side, nobody's perfect.

Anyone who tells you they're a perfect market timer isn't. The studies show that. So I'd say be more aggressive about making sure you invest for the long term, having enough in equities and balancing it out. Diversification is important.

But think long term, especially if you're at the stage of life where you're looking at wealth accumulation, whether that's for retirement, paying education bills, putting money aside for healthcare when you're older, or buying a second home.

You mentioned transparency on funds and what they hold. I read a damning piece earlier today about St. James's Place. For anyone who doesn't know them, they're an advisory firm, and they're not independent. It turns out one of their largest funds is about 14% invested in St. James's Place itself. The St. James's Place share price has nosedived this year, which means one of their larger funds has nosedived too, because it's so heavily invested in themselves.

Do you have any views on the financial advice space generally?

Finding a good advisor is important, because most people don't have the experience an advisor has. Assuming the advisor actually knows what they're talking about. There's a lot of bad advice out there, and a lot of free advice, which tends to be what I'd call a cookie-cutter approach.

One size fits all typically doesn't work very well. It's interesting, and you can learn from it, but everybody's situation is different. So from the customer's side, an advisor who listens and understands what the investor is trying to achieve becomes very important.

On the other side, you need to understand their conflicts and why they're making the recommendations they're making. To the extent they're selling funds they have an interest in, that sounds like a natural conflict. I believe St. James's Place outsources some of the money management itself.

So are those same money managers they're recommending to their clients rebating fees back to St. James's Place? Are you pushing the product with the highest fees, or the product that's actually best for that customer? You have to be very careful.

A good advisor is critical. I have a preference for advisors who aren't selling their own products, though in many markets that isn't always available. At the very least, there should be very good disclosure: if they're pushing a product with high fees, how much are they getting out of it?

Is their incentive misaligned with the customer's? Those are important issues to grapple with.

One of the reasons ETFs have grown so much in the US is that they moved a lot of investors out of house funds and high-fee funds offered by the wirehouses, and gave people something more transparent. There are some rebates even in ETFs that people don't realize.

But you're starting with a much lower-cost product, so that's better. It's never perfect. There are always going to be some fees. And understanding your advisor and making sure they provide the service you want goes beyond just financial advice. Are they providing estate planning? Tax advice? Do they have the capabilities you need?

Everybody's situation is different, which is why you have to understand what services they're providing and whether those are what you need.

One of the things I learned after doing my financial advice course is that in the UK we have a very clear distinction between guidance and advice.

Advice is about recommending a specific regulated product, whereas guidance is all the other bits and pieces around it, where you're not recommending a product, you're just laying out the options and trying to increase financial literacy.

You've had many years in the industry. What one thing would surprise most retail investors about the investment industry?

I think conflicts of interest are something people don't always appreciate.

You don't want to be cynical about it, but if somebody makes a recommendation, ask them why. If you go out and do it on your own, that's different. Then you've only got yourself to blame. But if you're relying on an advisor, you're...

hopefully they're acting in a fiduciary capacity. That's a legal concept that differs in every jurisdiction. But are they really looking out for your best interests? That's why the fee structure makes a difference, and the types of products they offer make a difference. It doesn't mean people shouldn't invest in private markets and things like that.

Those are appropriate for the right investor. But don't push one product just because your compensation as an advisor is tied to it. That, to me, is a problem. The other thing is that advisors sometimes look too much to the short term. I use the example of bringing a decorator into your house.

No decorator is going to come to your house and say, "This is perfect, you don't need to make any changes." Some advisors will always say, "I need to justify my existence, so I'm always going to be making changes." Sometimes the best advice is to do nothing. Playing the long game is important. The value of wealth accumulation comes from compounding low-cost products. That's a huge advantage. I know it's a bad analogy, but you want to be the house in a casino: in blackjack, everybody else goes bust first and the house is the last one standing.

You want to be the last one standing as an investor. So eliminate as many frictions as you can and play for the long term, because it's all about maximizing wealth for a given level of risk. If that comes from a simple product structure, why not? Don't overcomplicate things.

But complication comes with advice sometimes, because people have to justify what they're doing and try to look smart. And trust me, there are a lot of advisors who don't understand the products they're offering. There are some very good advisors out there, certainly.

But understanding and playing that long game sometimes conflicts with an advisor's interests. If you're paid an hourly fee or an annual retainer, or it's tied to asset levels but not to transactions, that's okay. You understand where their incentives come from.

What are your views on active versus passive?

The UK is famous for high-profile star portfolio managers, and they often live off the laurels of what they did five or ten years ago. They go through cycles. The studies show that over time, active managers tend not to outperform the relevant benchmark. That doesn't mean they can't in any one period, and it doesn't mean there aren't good active managers out there.

But doing it consistently, and knowing ahead of time. Can you know today who's going to outperform over the next five years? You can't. The studies show you can't. So you're getting the exposure, and the value comes from that exposure. In many cases you want a single fund that gives you exposure to equities across the globe, and they're available.

Most people know Warren Buffett, the Oracle of Omaha, as they say.

He made his money buying companies, not investing in stocks, as he'll tell you. But what did he say about his own estate, and where the money should go for his family? Into an index fund. Why? Because he said what he did is the exception, not the rule. He had access to information, and he had access to buying actual companies through their stock.

He very rarely sells them. He typically holds, because he's looking at the business, not the stock. But what he recommends to most people is to buy an index fund, because you're not going to have access to that same amount of information. And if you think you do, you're probably misguided.

Your listeners may remember the LIBOR scandal, which started in the UK. LIBOR was an index that was manipulated to suit the banks that were contributing the prices.

The daily LIBOR prices came from individual banks. It wasn't a traded price. It was a dealer saying, "Here's what I think the current offering rate is." And if it was a little higher or a little lower, that affected the P&L of their trading book. That's a conflict. The regulators got after it, unfortunately a little late, but that's why I come back to understanding conflicts and people's vested interests.

And on US markets, do you have any views or opinions on current valuations?

Honestly, I don't look at that. I tend to take a very long-term view, and I think that's important. I think things like dollar cost averaging make a lot of sense.

If you think you're going to pick the bottom and sell at the top, that's as much luck as it is skill. There are a lot of smart people trying to do that, and inevitably they're not always right. So you need to look through it. Does that mean you liquidate all your bonds and go into equities today? No.

But if you've built up your portfolio over time and you're looking out five or ten years, you shouldn't have to worry day to day. If you're investing every year, whether that's an ISA contribution or just normal investments, doing it over time works.

Sometimes you'll go in at the top, sometimes at the bottom. The point is to start saving, and save early, because the value of that compounding. Even a little bit of difference makes such a huge difference. Let me give you one example of why it's important to start investing early rather than later, why fees make a difference, and why you shouldn't worry so much about timing the market, because, as I said, you can be just as right as you are wrong.

Take two investors. One starts saving at 21, the other starts ten years later at 31. They each put £10,000 a year into an account, and they both get to 65. They contribute different amounts: if you start at 21, you've invested about £450,000 altogether.

At a 5% rate of return, that's worth almost £1.6 million. If that same investment earned half a percent less, and half a percent could easily be the fees in these funds, you'd be at about £1.4 million. So that's £100,000 over your lifetime, just because of half a percent. It makes a difference.

That, to me, is why ETFs and index trackers make sense: they're just a little bit lower cost. Now take the other example. You start at 31 rather than 21. By 65, at 5%, you'd have £900,000. So ten years' difference is a difference of £600,000.

You've invested £100,000 more, of course, but at the end you have £600,000 more. It's a huge difference. So: start early, compound, keep costs low. At the end of the day, it's about what you have left at 65. Hopefully you're around to enjoy it and it's not just going to your kids. But that's the game.

That's the game of growing wealth and accumulating it. Those are the important factors people don't appreciate. They say, "I'll start next year, I'll start next year." Start small. Not everybody can put aside £10,000 a year.

But if you can, it just shows you the difference. Start right away. Start right out of school. If you can do it in a tax-deferred account, whether that's company sponsored or an ISA, you're growing tax-free. It's a huge advantage, and you'll enjoy it down the road.

I was chatting to my nephew at the weekend. He's 21, on a year out from university and working, and he was asking whether he should opt into his company pension. I said, "Yes, absolutely."

Especially if they match. Do they match?

They do, and they match quite a lot. So I said, "Yes, please do. You have to." If you're asking that question, the answer is yes. You won't even realise the money isn't there. It goes into your pension tax-free, and you've got decades to go.

And you're doing it every paycheck.

So again, to your point about valuation, it's irrelevant, because you're going to dollar cost average, or pound cost average, for the UK. That's why starting young is so important. In the US they've just started these accounts they're calling Trump accounts.

Because compounding at a tax-free rate is the game.

It's that eighth wonder of the world, isn't it?

Without talking specific numbers, do you practise what you preach? Is your portfolio mostly index funds?

Yes. Other than some stock in companies I worked for, which I still hold.

Which is another issue, because concentrated positions aren't always a good thing. But sometimes you have tax issues if you sell. These are all issues I'm sure you know about. So I have some low-cost-basis stock that I can't afford to sell. If I do, I won't earn back the return.

It's interesting. There are loads of people with portfolios they don't want to touch or sell because of the tax. And I think you were the one who mentioned people holding old funds that aren't even performing well now. Old managed funds doing nothing for them, but they don't want to sell because of the tax.

Yes, they're locked in, and that's a problem. Managing things from a tax standpoint is important, so I do sell some of my company stock every year.

But I sell it for risk reasons, not tax reasons, because I know I'm not going to earn back what I'd pay in taxes. So I sell it down over time, and some of it will go through my estate. In the US you get a step-up in basis, so maybe my kids will enjoy it down the road.

Other than that, everything else I own is ETFs. I own a bunch of them. I own some core positions, and I have some I'll trade in and out of. Some country funds, some sector funds, and so on.

But I've built the portfolio around core investments that I don't touch. I just let it go. And then at the margin, right now I like Latin America, so I have some funds targeting that. I'd say it's a core-satellite approach.

For any new person just starting to invest here in the UK, the general guidance seems to be low-cost index funds, diversified. Don't go too wild to begin with, and over time learn what you want to put your money into.

Yes, absolutely.

And read, because there's so much information available that wasn't even ten years ago. That's a good thing.

One of the things I come across is people thinking they don't have the time to do it. But you can be a super lazy investor, right?

You just have a couple of things set up on a direct debit to buy every month, it goes in, and you can set and forget to a degree.

You know what? For a retirement plan, that's perfect. Like you say, it comes out of your paycheck and you don't even notice it.

You live to the bottom line, not the top line. That's the best thing that could happen. And the companies match it. Why not?

Thank you ever so much, Alex. This has been wonderful. Thank you for your time and for answering these questions.

My pleasure.