It sometimes feels as though there is something intrinsically corrupt about everything. Today’s papers are a case in point.
In the first two pages of the Evening Standard alone we learn that members of the House of Lords pocket up to £48,000 each a year in tax free expenses, money for which they never have to provide justifying receipts, and that Scotland Yard officers have recently managed to steal a whopping £1m from the tax payer via company issue American Express cards.
But very rarely does one see something in the papers that even begins to measure up to behaviour that passes for perfectly normal in the financial industry.
Look at the way shareholders in banks are ripped off by their senior management. Chuck Prince’s reward for making a mess of Citigroup (he resigned last week after the bank revealed $11bn in subprime related losses) was a pay off of $30m plus a car, driver, admin assistant and an office in Manhattan for five years.
To the rational man in the street this makes no sense at all. Not only is $30m a vast amount to pay for failure but the provision of an office, more staff than most of us ever have and a car is bemusing.
Why should the bank’s shareholder continue to support the ego (for this is what this boils down to) of a man they have already dumped for another five years?
The fees that eat into your returns
Next look at a slightly different aspect of the industry: the way we are regularly ripped off by fund managers. This is an issue at all times but particularly so in times of low returns (such as the ones it now looks like we are entering). When you are making 20% a year perhaps the odd 1% here or there doesn’t seem a big deal. But when you are making more like 5-7% it really is.
£10,000 invested in a fund that returns 7% a year will be worth £14,000 in five years if you pay no fees at all. Pay 1% a year and it will be worth £13,338. Pay 2% and your money will have grown to only £12,667. Over ten years the gap widens. With no charges the money is worth £19,670. At 1% it is £17,790 and at 2% it will be worth a mere £16,070 – over £3000 less.
Two percent is not an extreme number: the UK’s fund managers are very greedy indeed and annual management charges (AMCs) on most UK funds run on average at a far too high 1.5-1.7% (some are lower and a lot are higher).
There’s also a host of other charges involved in investing in most funds. In most cases legal fees, marketing costs, performance fees (which are becoming more and more common), admin fees and trading costs aren’t included in the AMC, making the full cost of owning most funds significantly higher.
Funds are also prone to putting their fees up without much warning – there is no unit holder body of any kind they have to negotiate with before doing so – and, worst of all, many of them charge exit fees too. So if you decide you don’t want to be invested in them any more, either because they are too expensive or they are underperforming the market (as the majority of them do) you can’t even sell them without paying another fee. Outrageous isn’t it? Particularly given that very few of these expensive managed funds ever manage to out perform the market as a whole anyway.
Cynical exploitation of ordinary people
However for the worst examples of the cynical exploitation of the general population by the financial services industry we have to look to the mortgage market. With Hometrack reporting that average house prices fell for the first time in two years in October and the Council of Mortgage Lenders forecasting that repossessions could rise by 50% in 2008 most rational people wouldn’t, I don’t think, feel that now is a particularly good time to be in negative equity.
Not so the mortgage sales teams at Abbey. No, they are still happily flogging their “100% plus” mortgage. This lets you borrow the full purchase price of the house or flat you want and for good measure another £25,000 on top of that.
What’s more, having dumped you into negative equity with the stroke of a pen, Abby also have a few suggestions about how you might spend the extra cash on offer –“renovating your home, buying a new car or consolidating all of your debts” perhaps.
This is shocking stuff. The first and last ideas aren’t great (if you can’t afford to renovate you shouldn’t do it, and debt consolidation usually leads to higher interest bills in the end) but the second – buying a car with mortgage debt – is completely insane. Why on earth would you borrow against one asset that is by most accounts already falling in value (your house) to buy one that will do the same just fast (a new car)?
Let’s say you borrow £125,000 on a £100,000 property. You then rush off to spend the left over £25,000 on a purple Audi A4. Depreciation on the car after a year will be at least £6,000 (and probably more).
So take one of these loans out now and assuming house prices don’t fall further, next November your assets will be worth only £119,000. That’s not good, given that your debt will still be near £125,000.
And if house prices keep falling, it will be even worse. Note that once you owe more on your house than you can sell if for you are trapped: you can’t sell it or your debt will fall due but staying – and continuing to pay interest you can’t really afford on the price of a depreciating asset is usually pretty miserable too. Anyone who falls for Abbey’s marketing nonsense this year will soon find that they have effectively sold their freedom for the price of a new car.
So there you go: whether you are a shareholder in a bank, an ordinary investor or just a mug of a first time buyer looking to get yourself a home, the financial industry has a special way of separating you from your cash. What can you do to stop them?
How not to line their pockets
You can amuse yourself watching the market giving the remaining big bank bosses their comeuppance (there is lots of hard work and not much in the way of bonuses in the stars for the next 3-4 years). You can stop buying over priced funds and invest via exchange traded funds (ETFs).
These have several virtues that should serve those who use them well over the next few years. The are cheap and easy to get in and out of; they charge low fees; and they offer direct exposure to all the most interesting bits of the market – oil, gold, silver and soft commodities.
And finally, you can stop listening to the hype from the mortgage lenders and if you can’t afford a proper mortgage on the kind of house you want to live in you can rent one instead (there’s little danger of losing out on the capital gains front these days).
Add that to cutting up your credit cards, never going over your overdraft limit, and not buying insurances you don’t need (as discussed here before) and you’ll have gone some way towards protecting yourself.