A lot of what we do at Stockopedia is based on the premise that it's not so hard for a typical investor to 'be their own fund manager' - that using the best quality fundamental data to implement a systematic approach to the stock market can reap substantial rewards over the long term. Yes you can beat the City.
But what I often hear from skeptics is that the costs of trading and rebalancing portfolios in this way are too much for an investor to bear. As ever in these things, it's best to argue with the facts so we thought we'd put together a little spreadsheet that illustrates at exactly which point it's financially worth running your own money versus sticking it in a fund.
What are the costs involved in running your own money?
Apart from time, there are several costs to running your own equity portfolio. These include the transaction costs of:
- Stamp duty/levy (typically a tax of 0.5% on purchases)
- Broker commission (a typical £10 per trade from many UK brokers)
- Bid/offer spread (what you pay to the market makers - 0.55% on average but can be just .05% for big caps but up to and beyond 1.5% for micro caps)
But there's also any self-advisory newsletter or service you might be using (in our case we will model the cost of a Stockopedia subscription at £179.99 per year).
What we've done in the spreadsheet attached is to take the above costs and model them against different equity portfolios based on the portfolio size and the number of stocks held.
Clearly as portfolio size increases the proportional costs of managing your money drop (as the fixed commission costs are proportionally lower), but as the number of stocks you own increases so do the costs of rebalancing the portfolio.
We have assumed that the portfolio turnover is 80% - that 80% of positions are bought and sold each year. This is actually the typical turnover of an average actively managed fund, so ideal for comparison, though quite possibley on the high side for an individual investor.
What are the costs of investing in a fund?
Our assumption is that we want to keep the annual cost of running our own money below 2.5% to 'beat' the cost of owning a fund. Fund expense ratios are often listed very appetisingly at e.g. 0.75%, but these fail to take into account a layer of hidden fees and transaction costs that can easily take the true cost of investing in a fund up to and beyond 2.5% or even 4% annnually - if you want to read up on this please see this link for an article we wrote on the subject - so don't get blind sided !
What did we find?
The optimal level of diversification for a portfolio is arguable - we model 25 stocks in each of our tracked 'guru models' on Stockopedia for safety and breadth, but some luminaries have argued that you only need 6-8 stocks to get the lions share of diversification benefits - you certainly don't need to own 100 like many mutual funds. It's fair to say that 15 stocks in a portfolio can give 87% of the benefits of full diversification.
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The spreadsheet shows that:
- You can run a £25k, 15 stock portfolio for a cost of under 2.5%.
- You can run a £50k, 25 stock portfolio for a cost of under 2%.
- You can run a £250k, 20 stock portfolio at a cost of 1%.
Basically it pays to be your own fund manager when you've got £25k or more. Anyone investing £10,000 may be better off investing in a fund or set of ETFs as the costs of wide diversification are cripplingly expensive - on the other hand, if you really know your stocks and pick your spots there's no reason why you can't get over a 5% annual hurdle - everyone has to start somewhere!
Getting started being your own fund manager
Over the last year at Stockopedia the majority of our'GuruModels' have substantially beaten the market with the average strategy clearing 20% in the last 6 months alone. While we hazard all our subscribers to do their own research and treat our research as a first step alone in their investment process these results have put most of the fund management community to shame.
We have seen how technology has disempowered intermediaries in the music and publishing industries and frankly we believe that much of the work done by the layers of intermediaries & advisers in the investment industry is smoke and mirrors. People shouldn't be wowed by the glitz or marketing dollars. Our goal is to help subscribers run their own money more cheaply and more profitably! If you haven't yet, then take a free trial to see what Stockopedia can do for your portfolio today.
(PS - If I've missed any costs let me know below in the comments and I'll amend the spreadsheet)
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7 Comments on this Article show/hide all
we believe that much of the work done by the layers of intermediaries & advisers in the investment industry is smoke and mirrors
This is (appropriately!) a more apt metaphor to use than you may have expected.
A large number of additional costs are bundled into the commissions that fund managers are charged by these intermediaries. These are not paid for out of the fund management firms own accounts. They are paid for by unit holders. The result is lower returns.
I have held a unit trust in an ISA for 12 years. I have never been charged an annual fee by the fund manager.
The annual income produced by the fund ain't much. I wonder why that might be.
They are taking customer's money without even saying they are doing so.
Of course when regulators have been asked to look into this (most famously, Lord Myners), I understand that they have pulled their punches in the interests of protecting the competitive position of the City of London versus Frankfurt etc.
Thanks for that Ed, anybody who asks about costs at different portfolio sizes, I'll point them to this article. I've always said that an investor should probably have 20 or 30 K in their portfolio before going down the stock picking route. Until you're at that level you might as well stick with funds IMO.
Thanks for this Ed. Is there a way to download the spreadsheet? I think I read it somewhere it is read-only on GDrive so everyone sees the same version. I'd like to play with the values, as I am in the happy position of getting a trade for a fiver.
In reply to seasons, post #3
Hi seasons - you can download the spreadsheet from this link (I hope!)
https://docs.google.com/spreadsheet/pub?key=0Am9qWxZqFje7dGQzUllkVWFWZ1JaWDNRQ0VDN3YxWlE&output=xls
Great article Ed. One other way I have found to build up positions cost effectively is to go down the regular investment route. TD Direct or iii (and others) allow regular monthly investment from £25 upwards into a basket of stocks - with iii in particular being very flexible in terms of the stocks they allow. Commissions are usually cheap - drawback is that they time the investment but you could always do larger sums in the months when you feel the prices are more favourable.
I find this to work well for smaller cap growth stocks - whose prices are often more volatile so pound cost averaging works well.
Must have missed this excellent article first time round.
I'd just like to add one further point. Most investors start off with portfolios at the smaller end of the range considered. However, it should be borne in mind that even though running a portfolio that size yourself may not appear economic, doing so is highly educational and puts you in good stead for running your own larger portolfio at a later stage, when the economic benefits of doing so are more obvious.
When I started off, many moons ago in my 20s, my portfolio was around £5K. The experience I gained then (and over the years) has proved invaluable for running my current portfolio, which is well into 6 figures.
Cheers,
Mark
In reply to marben100, post #6
Great point Marben - running a portfolio of only £5k in size may be expensive when considered in terms of transaction fees etc ( 6%+ ) but you are getting thousands of pounds worth of educational value for only a few hundred quid.
A very good point and just goes to show that intangibles aren't always on the balance sheet !