Economists can always prove us wrong but, in general, smart people tend to be better off. This group, or HNWs in the modern politically correct age, have a lot of calls on their time whether related to work or leisure. The best way to quantify that worth is to express it as an hourly rate. Bearing in mind that the minimum wage is £5.80 an hour a wealthy individual should be valuing his time at a large multiple of that, say 10 fold, thus making each hour worth over £50. If this person’s time is so valuable why would he want to waste it doing something that adds no value, and in fact probably detracts value, from his net worth; like managing his own money?
Consider a wealthy individual with an equity portfolio of £100,000 that he manages himself. Let’s assume his portfolio outperforms a comparable index fund (tracking, say, the FTSE 100) by 2% a year, every year. In his first year the market rises 10% and his portfolio rises 12% so he has added £2,000 to his net worth. The question to be asked is how much of his time did it take to achieve that? If he devotes an hour a week to the task over a year and assuming he takes a few weeks off over Christmas and the summer it is reasonable to suppose he devoted 50 hours. That means he made £40 for each hour devoted to his portfolio. That is about £10 less than his market rate.
Implicit is these assumptions are three crucial factors. First that he always beats the market and secondly, that he does it on a net basis after his dealing costs and thirdly that his return is achieved at no higher risk than a tracker fund. If his superior return is only 1% more than the market his one hour a week drops to a net value of £20. Even to achieve that net return he will probably have to achieve an additional gain of 0.2% to cover dealing costs and stamp on the assumption he trades once a month and to cover the fixed costs for his brokerage account. More worrying is the risk he has incurred. Higher returns, especially from small portfolios, are usually generated by taking more risk. In a down year that means his losses are likely to be…
Hi McEssex, interesting post - essentially, you're arguing the case for efficient markets, ie. the efficent market hypothesis. This has been discussed at some length in the past - see http://www.stockopedia.com/content/re-efficient-market-hypothesis/32272 - and the general consensus here is that it's codswallop. Now the general consenus may be wrong, I accept (it often is - see below). Nevertheless, you will find many investors that frequent this site and other sites that are able to deliver returns well in excess of the market, perhaps not consistently but certainly more often than blind chance or random variance. How is that possible? It's because, even if stocks in the FTSE 100 are relatively liquid and efficiently priced, enormous inefficiencies do exist in the smaller end of the market. Taking advantage of them can be difficult with wide spreads, but nevertheless they do seem to be there. I'd rather taking my chances hunting for them than just blindly following the aggregated choices of a large group of fund managers, most of whom seem more interested in hogging out on fees rather than capital growth, via an index fund but that's a matter of preference.
