It’s an unwritten rule that at some point every finance podcast needs to release an episode on the power of compound interest. Well this week, it’s Telescope Investing’s turn!
Money makes money. And the money that money makes, makes money
Benjamin Franklin
Successful investing really just boils down to just two things – picking good quality companies and holding them for a long-time. Time is the operative word in that statement, it takes decades for the exponential growth of compound interest to show its true power.
- It’s a rare investor that has a lifetime in the market, but over the very, very long run, compound interest can deliver staggering returns. Warren Buffett is the greatest living example of this. Over 99% of Warren’s net worth of ~$110B was accumulated after the age of 52, and one of the reasons he’s among the most successful investors of all time is that he started so early (buying his first stock when he was 11 years old) and has been investing for almost 80 years
- Berkshire Hathaway shares have grown on average 20% per year compounded since 1965. That doesn’t sound particularly exciting until you realise this means doubling your money every three and a half years. If you can do that for 80 years, you’ll end up with nearly eight million times the amount of money you started with
- Developing a savings habit and investing is one of the best things you can do for your future self, and one of the most common things we hear is that people wish they had started earlier. We both started investing in our twenties, but we wish that had been in our teens when we had summer jobs! You can jump-start this by investing for your children (or nieces and nephews). A small amount of money invested each year, compounded over 20 years, can give them a sizable base from which to build
- It’s said that “the first million is the hardest”, but even harder is the first $100K, and harder still is the first $10K. Investing at the beginning is hard because living expenses make up a large part of your income, and there may be little if anything left over to invest. As your investments grow, your passive income increases, and your living expenses as a percentage of your income drops. The goal of financial independence is for your passive income to cover your living expenses, at which point you’ve basically achieved financial freedom. You can do this by either increasing your passive income or reducing your living expenses, or ideally both!
- Fees and taxes on your investments can have a material impact on your returns, and this is magnified in the long run as those fees also compound! Passive index funds typically charge less than a 0.25% fee (some Vanguard funds are as low as 0.03%), compared to actively managed funds which are generally over 1% and can be as much as 2% annually plus a 20% charge on any profits made. This really adds up in the long-term, and it’s especially galling when you realise that most active fund managers actually underperform the market! Of course, there will be some funds that beat the index by a huge margin each year, but it’s almost impossible to pick who the winners will be, and it usually changes year to year. Most fund investors are far better off by “buying the market” through a low-cost passively-managed index fund, minimising their fees, and allowing full-reign to the power of compound interest
- We’re nearly twenty years into our own investing careers. If you haven’t begun your own journey yet, the most important takeaway from today’s pod is to just get started. The best time to start investing might have been twenty years ago, but the second-best time is today!
If you enjoyed this episode, please subscribe to the Telescope Investing podcast at Spotify, or on your podcast platform of choice
Transcript
Albert: Hi, this is Albert.
Luke: And this is Luke.
Albert: Today is Monday the 31st of May.
Luke: Happy bank holiday, Albert, and welcome to the Telescope Investing podcast.
Intro
Albert: Today, we’re going to have a chat about a topic that we’ve been thinking about for a few weeks now and that is compound interest and why it’s so important.
Luke: You know, every finance podcast has to do their compound interest episode, but hopefully, we’ve got a bit of a unique take on this. You know, I’ve been thinking about this topic right since the start. Compounding interest is actually the thing that got me interested in investing in the very first place. I remember I built a compound interest calculator spreadsheet for myself. Gosh, I must’ve been late twenties, and when I saw the eye-watering returns that were possible, that got me hooked.
Albert: Well, how realistic was this spreadsheet, Luke?
Luke: Well, I looked back at it the other day. Uh, I managed to find it. I found it on a work private folder somewhere. I know I built it in 2004. Unfortunately, it looks like I updated it in 2009, so I can’t find the original figures, but based on my 2009 projections, I’m actually tracking ahead of forecasts. So pretty good I think.
Albert: Oh wow, that’s great news. I don’t know what your aspirations are but if you’re ahead of your projections, that’s a good thing.
Luke: Well, thanks to the pandemic. It was a wild year last year.
Albert: Well, speaking of the pandemic, before we get to our main topic today, I saw a story last week. It was a story that my girlfriend sent me about how [in] Hong Kong, some property companies are offering a prize to vaccinated people in an effort to boost vaccination rates. I don’t know if you know, but in Hong Kong, the vaccination rates are quite low. After three months, only 18% of the population have had at least one dose and only 13% are fully vaccinated, and this is far short of the 70% needed for herd immunity.
Luke: That is shockingly low, actually. I knew it was low. I didn’t realize it was that low. What do you think the reason is? People are afraid or they just don’t have the time or they don’t understand why it’s important.
Albert: I think part of it is just a fear of side effects and maybe just because of complacency because Hong Kong has managed the outbreak quite well. Our infection rates are pretty low compared to a lot of other countries.
Luke: Ah, it makes sense, I guess, if you haven’t seen the impact and you haven’t seen the dead piled high, like countries like India unfortunately, maybe you don’t realize the true potential impact.
Albert: And I guess these Hong Kong property tycoons are so keen to get people back in their malls that they’re offering a prize of a new flat worth almost 11 million Hong Kong dollars for someone in September. I believe there are also 10 prizes of 100,000 Hong Kong dollars of spending credit, but the main prize is a brand new flat.
Luke: That’s pretty awesome. It’s hilarious that it’s private individuals, these property companies, offering the lottery prize. Makes absolute sense, right? Is the property market depressed because of COVID?
Albert: Maybe a little bit, but I think mainly, these property companies are making money from their commercial properties and they want people back in their stores, in restaurants and in shops, spending money so that companies will pay more rent in commercial properties.
Luke: Well, they haven’t had to do anything like that in the UK. Our rates are pretty high, but I do gather there was something similar in the US quite recently.
Albert: Yeah, I believe that some states are having lotteries for vaccinated people to boost vaccination rates. I think I’ve read that Ohio had one. Their program is called Vax-a-Million where each week someone over 18 who has been vaccinated will win $1 million and someone between the ages of 12 and 17 who has been vaccinated will win a four-year scholarship to an Ohio college or university, and the competition will run for 5 weeks. And I believe the first winner of the one million dollar prize was awarded last week to a 22-year old.
Luke: That’s great. In some ways, it’s kind of crazy that governments and companies have to offer these sorts of incentives. If the ends justify the means, it makes sense to me. It’s so important to get your population vaccinated and try and put COVID behind us, put it in the rearview. Whatever it takes to get us there. You’ve been vaccinated, right?
Albert: Yeah, I had my second shot about three weeks ago. In terms of side effects, I didn’t really get any in the first jab, but I remember in the second jab, I was just really tired for about two days, but apart from that, I was fine.
Luke: How do you distinguish that from your normal lazy malaise on a Sunday?
Albert: I had a two-hour nap instead of a one-hour one.
Luke: Set the alarm. Well, I’ve been double jabbed as well in the UK. I jumped on it and as soon as I got my invitation and was there days later getting jabbed, and I felt fine. Actually, if I really analyze what happened, after my first jab, my arm was a little bit sore for about three or four days.
Albert: Isn’t your arm usually tired?
Luke: Yes. Thank you. Most days. Um, and… other arm, Albert, other arm. You don’t want to get jammed in your main arm. Get jabbed in your off arm! Uh, but the second jab, completely fine. Even if I’ve been laid up for 24 hours plus feeling COVID symptoms from the jab, I would still be delighted to go get it. What’s one day of misery scheduled into your diary as opposed to potential risks of long-COVID, which frankly, for someone my age probably isn’t going to be death but could be severely laid up, exhausted, out of energy, and possible, very serious long-term impacts on health and physical fitness.
Albert: Yeah, but it’s fair to say that some people have experienced serious side effects from the jab, but as far as I know, nobody has died from the Pfizer job and people are dying every day from COVID.
Luke: It is complete nonsense, right? Everyone’s got caught up in this narrative around blood clots and everything else. You’re much more likely to get blood clots as a result of catching COVID if you don’t get jabbed. People are completely confused about this and they have it back to front. There’s a lot of fear-mongering. And so, maybe our official position on Telescope Investing is get out there and get the damn jab and encourage all your friends and family to do the same thing.
Albert: I agree, Luke.
Compounding returns
Albert: Well, let’s move on to our main topic of the week which is the power of compounding. I think I started thinking about this a few weeks ago when I was catching up on some videos from FinTwit 2021 and a guy called Daniel Sparks had a segment, and he said that successful investing boils down to just two things, picking good companies and time, lots of times.
Luke: Albert, we’ve been saying the same thing since day one of the podcast. I remember many times saying that successful investing is easy. All you have to do is pick good companies and hold them for a long time, and you’re right as is Daniel. Time is the operative word in that sentence.
Albert: Why is time so important? And it’s because of compound returns. Your money is growing at faster and faster rates.
Luke: I love the Benjamin Franklin quote, “Money makes money, and the money that money makes, makes money.” You earn interest on the money you saved, and then in the next cycle you earn interest on the money you saved plus the money you earn interest on, and it’s just a self-fulfilling cycle. And it’s very hard to get your head around what time can do. You bought a MacBook Pro recently, right?
Albert: Actually, I bought a MacBook Air, but yes, I bought a new MacBook.
Luke: So they’re like a thousand pounds, I think, a MacBook Air in the UK. So there’s this old anecdote about how you’d be a millionaire if instead of buying Macintosh products, you invested the same money in stock. Every time they release a new gadget, you bought that cost in stock. So let’s see what that MacBook Air might cost you in the long run instead of a thousand pounds cash out of your wallet. If you had bought the first iPad when it was released in April 2010, you could have spent $500 to buy that iPad, but if you bought Apple stock, you’d have $6,950 today.
There’s a whole raft of examples of this but I go right back to the very first Apple product, the first Macintosh released in 1984. Well, that was an eye-watering two and a half thousand dollars to buy at the time, 1984, but if you’d invested that two and a half thousand dollars in Apple stock, actually, if I’m honest, I’m not sure Apple were public at that time, but if you managed to privately buy their stock, that would be worth $2.2 million. A massive return.
Albert: You are cherry-picking a little bit by choosing Apple, which is one of the most successful stocks of all time, but I get your point and what I would say, if I didn’t have my MacBook Air, we couldn’t record this podcast. It has value above pure money.
Luke: I’m not criticizing that specific purchase, I’m just pointing out that that thousand pounds you spent on your MacBook Air, in 10 years’ time, that thousand pounds might be worth 10,000 pounds.
Albert: Well, all I say is that the MacBook Air that I bought this year replaced the MacBook Air that I bought about nine years ago, which I then sold for 20% of the purchase price. So I think I have my tech spending under control. What about you, Luke?
Luke: I’m pretty good. I’m good at selling stuff as well. Gadgets have great resale value, surprisingly high on eBay. So I definitely try and recycle my gadgets back into cash whenever I can.
Albert: Well, Apple products aside, I often do think about the crap I bought in previous years, all the money that I spent on these things that didn’t need and what would have happened if I’d used that money to invest instead. I have to say, it’s not good for my mental health.
Luke: There’s probably a gadget you can buy to monitor that.
Albert: Probably made by Apple as well.
Luke: The one thing I’m envious of… I live in the Android ecosystem, but I am envious of that Apple Watch. The health telemetry is pretty amazing. Tempted to buy one for my parents. I haven’t got around to it yet.
Albert: The investing strategy that we support at Telescope Investing, buy and hold, which is to buy good companies and just hold for the long term, and that sounds easy, right? Just to buy and hold, but most investors tinker with their investments too much, and I think we’re probably guilty of this to some extent.
Luke: Yeah, agree. I think you’ve got to water and manage your portfolio, but for sure, the number of things I’ve reduced the position to manage portfolio risk and I’ve just seen that stock go up and up and up and up, and if I’d done nothing, I’d be rich than I am today.
Albert: Actually, Daniel Sparks had a quote from George Soros in his segment on FinTwit, and George Soros once said, “If investing is entertaining, if you’re having fun, you’re probably not making any money. Good money is boring.”
Mid-ep promo
Luke: Hey, Albert, we should definitely make a mid-episode self-promotion part of our standard spiel. You know what else is boring? Hogging all the best podcasts to yourself and not telling your friends. If listeners are getting value out of Telescope Investing, let someone know. Maybe forward one of the emails. You know what I found the other day when I was running yesterday? In the Google podcast app, there is now a like button. Maybe it was always there, I never saw it before. Go hit that heart and you’ll see more episodes like this.
Albert: This reminds me of all the YouTubers that often start their videos with “Smash that like button.” You’re telling people to smash that like button in their podcast app.
Luke: People just go smash whatever it takes and help us magnify our reach, please.
Compounding debt
Albert: Well, we just discussed the power of compounding when it comes to your investments, but it also works the other way for debt. Many credit cards have interest rates of 20% or more, and it’s easy to see how credit card debt could spiral out of control. I think Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it earns it. He who doesn’t pays it.”
Luke: I’m sure that quote has been misattributed to Einstein, but the quote itself makes sense. Absolutely, if you’re in debt, unless it’s good debt like a mortgage, things like credit card debt can get messy. You’re basically paying that compound interest and you can get financially buried under something like that if you’re not on top of it.
Albert: Yeah, I had a small student loan when I finished university and the interest rate was very low, but it took me about 10 years to pay it off, and I did celebrate a little bit when that was finally paid off.
Luke: It’s good, right? We’re not a personal finance podcast, we’re all about investing, but there’s some great finance resources out there. And if you are sitting on higher interest debt and you’re thinking about investing, well, actually, you’re probably better off trying to clear that debt down first.
Albert: Yeah, it doesn’t make sense to make 10% from your investments when you’re paying 20% on your credit card.
Luke: Or even just to consider the risks, don’t get overexcited with the potential wild gains on things like Bitcoin and stocks and shares because that can go against you, and you might find in the short term, you make your debt position far worse than it is.
Realistic expectations
Albert: Now, as you just mentioned that these days people are expecting ridiculous 100% gains or more in weeks or days, but it’s useful to remember that the average stock market return is 10% per year. Most years it’s nowhere near 10%, it’s either much lower or much higher, but on average, it’s around 10%. And that doesn’t sound very exciting compared to the gains that some people are seeing with assets such as cryptocurrencies.
Luke: Yeah, having consistent returns over a long period of time is really the essence of good investing. I guess, in the rearview mirror, you can average these things out. Like when I calculate my own compound annual growth rate, my CAGR, it seems like a nice steady number, but if I go year by year, it’s wild swings. Years like last year of a hundred percent return and then some years of zero or even small negative numbers.
Albert: Yeah, a hundred percent returns is not normal. Like one of the most successful companies in the US is Berkshire Hathaway and their shares have grown on average 20% per year compounded since 1965. And if you don’t know, that is absolutely amazing, and it doesn’t sound particularly exciting, 20% until you realize that this means that it’s doubling every three and a half years.
Luke: I’m going to make a claim that my CAGR is better than Berkshire’s, albeit the number that they’re beating me on is time and time is the more important one. My CAGR over 17 years is publicized on my Twitter and it’s 26.5%, kicking Warren’s ass over a much shorter period of only 17 years, not 50 years. With a 26.5% CAGR, that’s like 10x’ing your money every nine years time. I somewhat tongue in cheek estimate it’s going to take me a total magical 42 years to billionaire status. So I’m 17 years into that 42-year journey. I guess if my investment career was compressed down to a week, it’s currently 7:00 PM or Wednesday, but weekend’s in insight.
Albert: 42 is the answer to everything.
Luke: It certainly is.
Albert: Well, I haven’t double-checked your calculations, Luke, and if that number is true, that is amazing. You can soundly say that you are a better investor than Warren Buffett. I haven’t calculated my CAGR in the level of detail that you have. I think I’ve done pretty well. It’s probably between 15 and 20%.
The importance of time
Luke: Both great numbers, but as we observed, like time is the most important thing. You and I have been in this market for say, 20 years, but Warren’s been doing this for over 80 years. That’s longer than most people live. And there’s an interesting stat published by Morgan Housel in his excellent book, The Psychology of Money, that observed why Buffett’s one of the most successful investors of all time, and this is that he started when he was 11 years and, as you say, he’s been going on for 80 years. You know, the magic of compound interest means that Warren’s net worth [of] $110 billion, he made 99% of that after he was 52. So you and I are still south of 50, it’s all to play for.
Albert: I was quite inspired when I read that because neither you or I are 52 yet so we still have quite a lot of time. Warren is doing well for age 90 to invest at that level over 40 years after the age of 52.
Luke: And I think the key message here is if you haven’t started investing or saving, get started. That’s the most important thing, and people can get caught up in this fear about maybe the market’s too rich and maybe valuations are at an all-time high and I shouldn’t start. The more important thing is just suck it up and get going.
It makes me think of our conversations with our good friends, Ram and Reuben, and middle of last year, I had that jokey billionaire conversation with the guys over a year and a half ago while we were on a motorcycle trip. And it took another six or seven months before Reuben finally said, “Hey, tell me about this investing thing that you guys are doing,” and they kind of got on board with their own investing journeys in June or July last year.
Well, in retrospect, that was a terrible time to start because valuations were super high, mid-pandemic, and they’re both suffering drawdowns year to date, albeit fairly small, but just the fact that they’ve got started and they’re on this journey is the more important thing. And I think dollar-cost averaging your way into positions, as we were talking about on a recent episode, is a great way to mitigate the short term fluctuations in the market.
Albert: Yeah. I completely agree, Luke, and one of the common things that we hear from people is that they wish they had started investing earlier. I started investing after I graduated from university and I really wish I’d started in my teens when I started my summer jobs. I had all the spare cash from working summers and I just wasted it on computer games. Actually, the only thing useful I use that money for was my driving lessons. All the rest was just frittered away.
Luke: You’ve got a driving license? I had no idea.
Albert: Yes, Luke, I have a driving license, but I haven’t driven for many years since you don’t need to drive that much in Hong Kong.
Luke: Now you say it, I do remember the anecdote of your epic car crash in the nineties.
Starting early
Albert: And there are a lot of examples on the web on the effect of waiting just a few years before contributing to your pension, but I found one. If you invest $6,000 every year into your pension that is returning 7% per year, and you start at age 45, you will have around $245,000 by the age of 65. Not bad, right? But if you start at 35, you will end up with 566,000, and if you start at 25, you will end up with 1,197,000. That’s a big difference.
Luke: It is a big difference. You know, they say the first million is the hardest, but even harder is the first hundred thousand, and I guess, harder still is the first 10,000. You have to get that compounding machine running and it does need infusion of cash to make it happen. That’s why, I guess, at the early part of your investing career, actually, your ability to save money is more important than your investing judgment. You just need to start building that pot so that compounding starts to do its magic.
Albert: I guess the reason why it’s so difficult at the beginning is because your living expenses make up such a huge percentage of your income and you can’t save that much. As your investments grow and your passive income grows, your living expenses, hopefully, should be a lower percentage of your overall income and your savings rate can increase. But the problem is that many people when they earn more, they also spend more and they just have higher living standards, and their savings rate does not increase. I guess they get on what is called the hedonic treadmill, where they spend more as they earn more.
Luke: Hey, the hedonic treadmill, isn’t that the new product from Peloton?
Albert: They should call it that considering how much it costs.
Luke: Exactly! A $2,000 treadmill. Good god!
Albert: Yeah, the goal of financial independence, I guess, in these FIRE circles is for your passive income to cover your living expenses so that you can basically retire and not worry about working again. And you can either do this by increasing your passive income or reducing your living expenses or ideally, both.
Luke: You know Warren Buffett started investing when he was 11, and you can get this journey started much younger than 11 if you invest for your kids and build their own investments from really the day they born. I started this for my nieces and nephews, and I buy them a story stock every year. Unfortunately, this year I bought them all Teladoc and that’s in the bin. I don’t think they know, but in the long run, I expect that to form part of that billion dollars if they keep this up.
Albert: You’re clearly a better uncle than me, Luke, but I’ll add that my nieces and nephews are in my will.
Luke: Hey, you know what’s in my will? That made me think of a quite funny anecdote. A good buddy, Shen, and I, and we’ve both been close snowboarding buddies and we’ve done some pretty hardcore snowboarding trips in the past. Generally, every holiday ends with one or the other of us ending up in hospital. As a bit of a joke, I bequeathed my motorcycle to Shen on the assumption that I don’t die on the motorcycle in my will.
And I remember a particularly gnarly spot we found ourselves in. We just dropped off into the side country and the slope just ran out into little mini avalanche below us and it was all just rocks and brambles and basically, death. So we had to climb our way out of this thing. It took a good half an hour to climb out and we were half-laughing and half-horrified and trying to keep within grabbing range of each other in case one of us went. Uh, we got out of it and over a beer at the bottom of that mountain that day, Shen said to me, “That was pretty bad, dude. I thought I was going to win the bike,” and I’m like, “Win the bike? You’re not winning anything if I die!”
Albert: Wait a minute, Luke, you said Shen gets the bike if you don’t die on the bike, but what if you do? I don’t want to sound morbid, but what if you do?
Luke: Then no bike for him. I’m not bequeathing him my bloody remains.
Albert: Actually, I only sorted on my will last year. I’ve been meaning to do my will for many years, probably like over 10 years. For some reason, the thought of a deadly pandemic really pushed me to finish it. I have to say once I got it done, it was a huge relief.
Luke: Am I going to win anything when you spring this mortal coil?
Albert: I haven’t put it in the will officially, but you can have my podcast mic.
Luke: Uh, nice. I could use a backup. Let me get my epitaph prepared.
Albert: Actually, we had a fantastic conversation with our friend Ramesh about saving for your kids back in episode 12 of the podcast, so if listeners are interested, they can go back to that. Well, if we look at really rich families and really rich people, they have what is called generational wealth, where their wealth has been compounding over decades or even centuries. All it takes is just one idiot to ruin that though.
Luke: One spendthrift idiot or perhaps just bad tax planning. You know, most inheritance tax is supposed to spread the wealth when it gets inherited from generation to generation, but actually, if you’re smart and you’ve got significant money, there are still so many dodges in most countries of ways of avoiding inheritance tax.
Impact of fees
Albert: Well, speaking of taxes, Luke, one thing you want to avoid when investing is excessive fees and taxes – trading fees, management fees, dividend tax, and capital gains tax.
Luke: Yeah, they can really be a headwind to getting that compounding machine running. I ran a few numbers myself over the weekend to see how tax could impact your compounding growth. If you started out with nothing and you invest a hundred dollars a month for 20 years, and when you’re investing a really great way to avoid fees and taxes is to invest in passive index funds rather than actively managed funds. And we’ve always said, funds are the best way to mitigate your risk while building up an initial pot before you start branching out into individual stocks.
Well, some of these active funds have quite high fees, and that can really be a headwind on building in the early years. You know, if you start out with nothing and you invest just a hundred dollars a month for 20 years, but if you invest in a passive index fund, typically fees are around 0.25%, actually, there are some funds like Vanguard ETF where it’s 0.03%. Now, you can get those fees really, really low, but if you’re paying 0.25% and the market averages, let’s say 10% per annum, after 20 years, you’re going to finish off with $74,000. That’s pretty good.
But if you’d invested that same money in an active fund, and if I choose an optimistic active fund that charges just a 1% fee, some are much higher, well just that extra three-quarters of a percent reduces your total pot at the end of those 20 years to 65,000, nearly a 10K difference just because you paid less than 1% extra in fees.
Albert: Well, there’s a reason why your fund manager has a private yacht and you probably don’t.
Luke: Exactly. Those guys make money whether things are going up or down. It’s the investor really who pays the toll.
Albert: Well, what can we do about that, Luke? We often say that fund investing is probably the best option for most people.
Luke: Use whatever tax-advantaged opportunities available in your own country. In the UK, that’s something called an ISA. If you’re investing for your kids, a Junior ISA. You’re paying money in where all your capital gains are tax-free.
Albert: Yeah, and I’m very lucky to be in Hong Kong because there are no taxes on investment income in Hong Kong. No taxes on dividend income and no taxes on capital gains. However, I do think that we’ve been quite lucky in that we’ve been investing during a massive 10-year bull run from 2009 to 2020. This is the period when we were investing in earnest.
Luke: Well, maybe that is the source of our crazy returns over 20 years. I’m going to lean on that old poker saying I’d rather be lucky than good.
Albert: Definitely but being good also helps, you know. Speaking of funds, Luke, well, we said fund investing is probably the best choice for most people, but you need to make sure that your returns are not eaten up by management fees. And the typical annual management fee for an actively managed fund is around 2%, which doesn’t sound very much, but it really adds up over time and your example really helped to illustrate that.
You mentioned Vanguard and they really spearheaded the low-cost index-tracking fund business, and they now have around $7.1 trillion under management so I think a lot of people agree with that. People are piling into passively managed funds, but there are also these other funds which are actively managed and have high fees such as hedge funds, for example, and their fee structure is often what is called 2+20, which means they charge 2% of the value of the assets as a management fee and take 20% of the profits. And a quick back of the envelope calculation tells me that the assets in this fund must make a return of 15% for the investor to get the 10% that you would get from investing in the S&P.
Luke: Yeah, fees kill you. You might be lucky and choose the investment manager who outperforms the market that year, but that same guy is probably not going to outperform the market the year after. It’s a total lottery and on average, these guys who are managing active funds underperform the market.
Albert: Maybe people don’t realize that the S&P 500 has outperformed the average hedge fund over the last 10 years. The S&P has an average annual return of 14.4% in that period while the average hedge fund has returned around 5%. And one of the reasons why that is [is] because during that entire time, the hedge fund managers are extracting their fees whether or not the funds go up or down. They getting paid regardless.
Luke: Right. It’s a great business to be in but only if you’re managing a fund, not if you’re investing in it.
Albert: Even star fund managers can stumble hard. You may remember the story about Neil Woodford in the UK. Like Neil Woodford was a star fund manager when he was working in Invesco Perpetual, where he had an amazing run as a fund manager there. £1000 invested with him in 1988 turned into over £25,000 25 years later, and the FTSE in that time only reached £10,000. And after this, he left Invesco Perpetual to start his own business in 2014, but this was forced to close down in 2019 after suffering huge losses during a bull market and investors were pulling out.
Luke: Yeah, his assets under management dropped from $10 billion in mid-2017 to just $3 billion in mid-19. Pretty much wiped out by people running for the exits when it started to be signs of weakness in his results.
Albert: And this was during a time when the market was doing really well. I do wonder whether this was due to overconfidence on Woodford’s part or he was just unlucky. In the end, it doesn’t really matter. It’s just very hard to achieve high rates of return over a long period of time. People like Warren Buffett are more the exception than the norm.
Key takeaways
Luke: Well, that was a good round-up. Let’s try and bring it together for a couple of key takeaways for today’s episode.
Albert: What we’re trying to say is time in the market is more important than timing the market, and you just need to get. The hardest part about investing sometimes is just to get started.
Luke: And we can’t overestimate the value of time and patience. The earlier you start and try not to fiddle too much. Try and have a strategy, invest with a plan, and just be patient. Give time the chance to work its magic.
Albert: Watch out for high taxes and high fees and use tax-free shelters if possible, such as ISAs in the UK,
Luke: Try and find products that have low fees. You don’t want to be using your money to make somebody else rich.
Wrap
Albert: Well, that was an interesting conversation, Luke, and I hope listeners have found that useful. And that’s all for this week. Thanks for listening.
Luke: If there’s a future topic you’d like us to cover, you can message us on Twitter. I’m @LukeTelescope.
Albert: And I’m @AlbertTelescope, or you can email us at feedback@telescopeinvesting.com.
Luke: If you enjoyed today’s episode, you can find more content at our website, telescopeinvesting.com, where you can leave us a comment or a review.
Albert: And if this is your first time tuning in, perhaps consider subscribing to the website so that you’re the first to hear about new articles and episodes as they drop.
Luke: Thanks, Albert.
Albert: Thanks, Luke.
