23 May 2014, 12:43pm
personal finance:
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  • The subtle way Hargreaves Lansdown make their money

    One of the things I rather admire about Hargreaves Lansdown is the slickness of their operation. It’s a full-service shop, and the Ermine is nowhere near rich enough to fly First Class, use valet parking, or invest with Hargreaves Lansdown.

    Managing your income is an excellent way to stop feeding the Beast of HMRC – as a PAYE grunt paying the mortgage there were only limited ways I could do this, basically pension AVCs and employee Share Incentive Programmes though the latter were only good for sheltering about £1.5k from tax a year. However, it means an Ermine is now sitting in First Class of the investing platform world albeit with a cattle class ticket, and I get to see how HL works.

    One of the things you notice about First Class 1 is that paper is king. Ditto with HL, so the Ermine has this lot on the dining table –

    A single mailing from HL

    A single mailing from HL

    I recently read this article in the Grauiniad, which chimed in with the book Authenticity: what consumers really want I read from the library a while back, that we are increasingly being sold lifestyles rather than specific products. I’m still not sure whether the Grauniad article is really insightful or absolute bollocks, but anything that makes me think has been time well used IMO. A great quote is

    This is how capitalism, at the level of consumption, has integrated the legacy of 1968, the critique of alienated consumption: authentic experience matters.

    And I thought of that when I looked at this wodge of HL stuff. Clearly HL targets their advertising a people of a certain age, preferably people who have more money than I have and therefore can afford to not look a the price ticket too much 🙂 One of the things that struck me is that it’s all about funds. For historical reasons I’ve never been that much about funds and the way the whole market is going I am going to get out of funds all together, because they induce platform fees whereas so far you can avoid platform fees on things like shares and ETFs. Not only that, but funds seem to offer the opportunity for all sorts of indirection and fees upon fees. This is clearly how HL operate. Their fundamental platform fee is 0.45% 2  – bearing in mind the long-term return form stocks is typically estimated at ~5% you’re paying a 10% income tax right off the bat, just for being there. The reason I have left my money there as cash is that this fee doesn’t exist for cash, though obviously you are paying the government about 3% inflation tax to manage the money supply for the benefit of mortgaged homeowners to depreciate the currency 😉 However, since they are giving me back a load of tax I paid in previous years I can eat that.

    However, riffling through the HL paperwork, this is clearly a fund shop, and the fee loadings on the funds are usually over 0.5% so you’re looking at fees of over 1% just to be in the market. Annually. The Ermine is just not used to the concept of being rushed each and every year just to exist. But the words are warm, in the typical vapid style when talking about the unknowable future. Everything is good, and if it isn’t, it’s suffered a temporary setback and is an excellent buying opportunity. There was one chart that made me sit up and go WTF, which was the chart of the UK stock market by CAPE

    The UK stock market - good value right now

    The UK stock market – good value right now

    Now I look at that and think bloody hell, the reason I haven’t yet sorted out what I am doing this year is that the market looks on the upper side of the good value line to me. Better people have suggested that it isn’t so much the headline FTSE100 price level but that earnings are improving, but nevertheless I’ve still got some feeling for the WTF are we doing up here mate fellow, though it’s not as bad as it was maybe. That’s why I am looking at emerging markets, and Russia still draws me, with their PE of 5 nowadays, but I still can’t get my head round what exactly the meaning of the word ‘ownership’ is in a Russian context 😉

    Anyway, the UK stock market – good value by historical CAPE? There are three things wrong with that. The first is look at that great big spike from the mid-Nineties up. That, my friends, was called the dotcom boom. Everybody was charging around like blue-arsed flies buying anything with internet in it. Then anything with www. then any company with an e in the name. Seriously, it was a real case of the madness of crowds. Everybody’s brains fell out on the floor and some people are still looking for theirs fifteen years later. I was there. It really was that mad. I made about quarter of my gross salary in the run-up. And lost half in the bust 😉 The training was excellent value, because I learned not to buy into momentum. You will run out of greater fools, because in general you are one of them.

    Just like Mark Twain said about the unique learning you get from carrying a cat by it’s tail 3there are some things you have to do to learn things in a way you can’t learn any other way.

    A man who carries a cat by the tail learns something he can learn in no other way

    Same with the madness of crowds, You gotta be in it to know it. The trick to success is to retain that knowledge  for future use. It’s always a fight…

    If we lop out that piece of irrational exuberance, the chart doesn’t look quite so wild, and there’s also a general downtrend, possibly because the power-shift from the West means the market may be prepared to pay less for any given earnings because it suspects that profitability is falling. After all, with the level of debt both personal and national, where’s the money going to come from to buy your stuff 10,20 years down the line? We can’t all keep borrowing from the Chinese 😉

    Standard Deviation? On Stock prices? Mr Gauss would not approve, m’lud

    The second thing wrong with this is that the trouble with using things like standard deviation on stock prices is that stock markets do not obey the central limit theorem. Mr Market is not a collection of independent random variables, and every so often everybody decides “Holy shit, the world is going to end”. On the flipside, we all sometimes decide that it’s all different now and we have reached a plateau of permanently increased productivity, which leads to irrational exuberance about stock prices. In priciple a government can row back against that by increasing interest rates, but on the other hand they can promise all sorts of Good Stuff to the electorate to get re-elected. Any resemblance to Help To Buy is of course purely coincidental. As a result, the distribution is fat-tailed and is not typical of a normal distribution, so using standard deviation of a normal distribution is iffy. Companies got into hot water with their value at risk calculations because they were seeing events that typically you’d only expect to see in longer than the age of the universe – in about ten years. It actually staggers me, that, in trying to substantiate this paragraph, I discovered people really did use the normal distribution as the model for financial markets.

    I am sure that once upon a time, the level of general and scientific knowledge in the West was widespread enough that it would have been obvious what was wrong with doing that to people in a professional organisation. We seem to search more and more for stupid metrics and valueless numbers rather than seeking knowledge. The world is complex, it’s messy, and one size rarely fits all. The abuse of the scientific heritage of the West that this represents is shocking. This is not new stuff – Carl Gauss died in 1855. Mind you, to my shame I only scored a lousy 5 on the Grauniad’s science quiz so clearly the rot is spreading. But I’m not in charge of shedloads of other people’s money.

    Have you ever seen what happens in a mass of humans when somebody yells Fire? They all lock into each other and start running the same way. That is not a canonical example of a set of mutually independent variables acting individually, so the central limit theorem breaks down. In crises – at the very time when you need your model to work to qualify the severity of the problem. Maths doesn’t help you in dealing with human emotion.

    The third thing wrong with that chart is the data source: internal, with the data set from Jan 1974 giving a veneer of respectability to something that, basically, HL could have made up entirely. And since they benefit from shifting your cash into their funds there’s always the temptation. You can’t validate that data against anything. HL might well have said “trust me, I’m a salesman”.

    I have nothing but admiration for HL

    HL did serve we well when the Chancellor decided to improve the usefulness of DC pension savings no end – just before the end of the tax year! So I needed a place to stash £2880 with a pension firm, pronto, and HL were the only people who managed to open an account and take the money, within a week. TD, my current ISA provider, demanded proof of identity through the post, because their system isn’t joined up presumably, and Cavendish were also after that.

    Now the ermine is not a million years away from getting my hands on that money back, and in a rare turn-up for the books, I can claim back 20% of the tax I paid on earning that money – by simply leaving it with HL and HMRC will add £720 to my £2880. That’s an effective interest rate on cash of about 12% (it’s amortised over two and a bit years) and I can do the same next year and the year after that, for an interest rate of about 20%. I don’t know about you, but I sure as hell don’t know anywhere you can turn that sort of interest rate on cash. Okay, so it is only the money stolen from historical pay packets being returned to me, but it’s worth shifting an Ermine paw and banking with the might of SIPP rather than the Nationwide. I stand to win about £2000 back from HMRC. The trick, of course, is to manage one’s income and make sure I don’t have any when I hook this cash back out – it’s about £10800 which is currently above the personal allowance, but you can get 25% of it tax-free. By living on this for a year I get to defer my main pension, too, which goes up by ~5% each year I defer. Although actually 4% since HMRC will be tapping me for tax- I’m tempted to save my taxable part of the pension into a SIPP to reduce the tax on my pension to 15% since I can manage the cash-flow. The main challenge is having enough cash reserves to keep loading my ISA allowance each year, which has suddenly got a bit harder with the increased allowance. I may consider taking out an cash loan for the last year, if anybody will lend me some money, simply to fill up that ISA allowance. 4

    The Ermine has been freeloading on the money that fund investors have been putting in for years when it comes to the costs of running a platform. I don’t need the lifestyle stuff, but I’m happy for it to pay for my seat on the boat. Most of HL’s customers have a lot more money than I have, so every so often they may see the flash of white fur and a small black tip to the tail scurrying about, but in the end it’s the rake of their wealth that is keeping this ship afloat and in good condition. I salute my well-heeled fellow passengers and raise a glass of proscetto to their choice of lifestyle, if not their quest for value for money. Perhaps the Guardian article was right. When you have enough, you don’t need to seek value for money. The quality of the ride may matter more. HL is selling an experience – giving you the warm feeling

    “You are a wealthy sort of chap, probably a chap, probably 50+. You are knowledgeable in the ways of the world, so here is a shitload of complexity and a teeny bit of salami-slicing of fees. Needless to say, an experienced individual of your calibre has the savvy to make shitloads of money from these fine opportunities despite the fees, so take it away from here. For those of you into shares, we now offer real time live share prices, so you can ride the markets like a pro. Come on in”

    And they do – HL is apparently one of the biggest retail investment platforms in the UK.It’s a slick operation, and probably a nice ride. just not the cheapest. Except for their okay 0% rate on cash, which will do me fine. I live in hope that the new NISA integrated accounts will actually pay you a return on cash, but it’ll never approach the HMRC rate on a SIPP.

    Notes:

    1. I’ve never flown First Class, though I flew Business class enough for work, and you got a lot more bumph there too compared to cattle. But it’s a long time since I have boarded an aircraft – not because I can’t afford it but the experience is so horrible and I get to hate my fellow humans so much for their screaming brats and inability to follow written instructions holding up the queues. So I really try not to do that to myself, or them.
    2. capped at £200, corresponding to an account value of £45k. Now my ISA is more than that, but I don’t currently pay £200 to TD to hold it. I checked last year’s statement and my platform fee was £2.31, so HL are 8600% dearer. In fairness, I made 9 purchases and zero disposals, and HL are 65p cheaper on share purchases, so the difference of £5.85 should be added to TD. So HL is only 2450% dearer than TD, a much more manageable difference for some chrome trim and a slicker operation, no?
    3. I suspect he didn’t say that directly, it is a paraphrase of  Tom Sawyer’sa person that started in to carry a cat home by the tail was getting knowledge that was always going to be useful to him, and warn’t ever going to grow dim or doubtful” but I’m damned if I’m going to surrender the thought picture on the altar of technical accuracy.
    4. You should never, ever, borrow money to invest in the stock market. However, I have a large AVC fund that is in cash and can come out when my main pension commences. So I am not borrowing money I don’t have, I am borrowing money that I can’t access yet. If you want to borrow money to invest then you may as well go into spread-betting.
     
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