Investor Be Warned
Newcastle Herald
Monday April 29, 2002
A recent well-publicised court case is a reminder of what are reasonable rates of return.
LAST week a retiree, Rahmat Ali, won more than a million dollars damages from a Perth-based stockbroker who had traded away all his retirement assets.
The decision is welcome as it is a victory for the little man but it is also an opportunity for investors to educate themselves on what they can expect from an adviser and what are reasonable rates of return.
In the case in question the retiree had been promised a return of 15 to 20 per cent a month on his portfolio of $300,000 and was told this was `achievable' and `not risky'.
The returns never eventuated with the stockbroker making trades of more than $39million on which he earned brokerage of more than $134,000. In the end the client lost the lot.
Investors can be reassured that this is a most unusual situation. A huge percentage of the investment dollar is placed in managed funds run by respected fund managers such as Advance, Perpetual, Colonial, ING, Rothschild and MLC who have strict processes in place to ensure that no more than a fixed percentage is invested in any one stock.
This is where your work superannuation money is probably invested. As these funds are invested in shares, you can expect the value of your investment to move around somewhat in sync with the market. When the market falls, your money may fall with it, when the market rises, your money should bounce back.
There are also thousands of investors who hold shares directly and who buy and sell under advice from their stockbroker.
Even though the stockbroker makes the recommendations, it is the client who makes the final decisions and almost certainly continually monitors the results.
Despite all the enticing advertisements around, it is generally recognised that a reasonable return from growth investments is inflation plus about 6% per annum.
Therefore, if inflation is 3%, you should be well satisfied with a return of nine or 10 per cent. It is possible to achieve higher returns if you borrow for investment but this carries a higher degree of risk.
For example, if in March 1992 you borrowed $100,000 on a home equity loan and invested that in a share trust that matched the All Industrials Accumulation Index, you would now have $350,000.
That's a return of 13% per annum compound on the initial $100,000 invested. However, you didn't put up $100,000 because you took a loan against the equity in your house.
Your total investment is only the tax-deductible interest. In the past 10 years, borrowing rates have moved about but if we take 8% as a reasonable average, we can assume our total investment was a tax- deductible $8000 a year or $80,000 over the period of the investment.
When you punch an investment of $8000 a year into a financial calculator you discover that you have earned 20% per annum if your investment is worth $250,000 ($350,000 less $100,000 loan) after 10 years. This illustrates how borrowing can significantly boost returns.
I am ignoring tax because the payments are tax deductible but there is some compensating tax on the reinvested income.
The court decision also reinforces what we in the profession call the `know your client' rule. The laws require advisers to work from three basic premises: know your client, know your investment products and produce an appropriate strategy.
On your first visit to an adviser you'll be asked to complete a detailed form that will include details of your assets, liabilities, income, risk tolerance and expectations. From this the adviser should determine what investment strategies are appropriate for you.
This is then formalised into a written portfolio that also details the expected behaviour of the assets in it and details of all fees and charges.
While aggressive share trading may be appropriate for a portion of the assets of a high-income sophisticated investor, it is certainly not appropriate for a retiree who is inexperienced in the market.
Investors should never forget the adage: the higher the return, the higher the risk. Promised returns of more than 10% should always ring warning bells. Noel Whittaker is the author of nine books on personal finance.
© 2002 Newcastle Herald