44

I am really new to investing and I am so confused. Books, blogs and conferences suggest that investing is the way to multiply wealth. I do not have enough start up money to play with mutual funds, therefore I am looking at ETF funds to start.

I used Wealthify to calculate some projected gains. Based on pumping in £50 a month for 5 years (about £3k after 5 years), if I play it risky I will make less than £300 pounds after 5 years! Seriously? This is considered good? Bear in mind that this is the highest risk option. Playing it safe gets me only £100 in 5 years.

What am I missing? Why is investing a good idea? Or is the myth true that you need lots of money to invest in order to achieve a reasonable return?

Please advise.

Please see screenshot for reference on the projected gains.

enter image description here

  • 4
    Guess which company is future equivalent of Apple, buy shares and get 500% returns after 5 years. With "guaranteed" profit the percent is like 10% or similar value. – i486 Jan 1 at 22:18
  • This might be helpful money.stackexchange.com/questions/102307/… – quid Jan 1 at 22:33
  • 49
    Your math is way, way off. You may have deposited £3000 but not for the full 5 years. The math is complicated but the average amount in the account was more like £1500, and £328 gain on that is not 10% at all. – Harper Jan 2 at 0:15
  • 15
    Shop around. You can do better than 1% fees. – Nathan Cooper Jan 2 at 0:47
  • what @NathanCooper said. Most banks and brokers won't give you better ratings if you ask, but if you have a better quote from a competitor they suddenly get you a counter-offer. Shop around. – Mindwin Jan 3 at 14:05
119

You grossly miscalculated because you forgot that money has to actually be in the account to earn. You earn nothing on the £50 you haven't deposited yet. And that is the first problem: compounding isn't working for you because compounding takes time, and only 600 quid is even in there for 4 years.

You're getting fleeced

Adjust for the above, and the return is more like 20% or 4% per year...but that itself is pretty lousy. This is a terrible investment.

I tried a few different numbers into this thing. Increasing number of years yields a disproportionate return, and that tells me they are chomping off a fairly substantial "front end load" that seems to resemble the 5.25% that is typical in the traditional "sucker bet" investment industry. So every month only £47 is making it into the fund, for a total of £2843 actually invested. Obviously that consumes 5% of your returns, but it's worse, because that 5% also doesn't compound over the 5 years, eating another 1% in your scenario.

Given the dismal returns, it is also obvious that they are placing your money in traditional managed mutual funds with about a 1.5% expense ratio. That means every year what you would have made, you make about 1.4% less. That guaranteed total loss compounds too, so adds up to about 8% in 5 years, except you only invested for half the period, so more like 4% over the 5 years.

So, the 20% you did get get plus 6% load lost, plus 4% expense ratio lost, puts us at 30% which is still sub-par for 5 years. Where else is it going? Well, Investify is providing you a soup to nuts, turnkey solution, that "pretties investing all up" for you, makes it seem acessible, and takes the fear out of it. Investing for morons: throw money at them, and they invest it. They are gouging you for a couple percentage points a year for that "service".

... (on top of the ~5% kickback since the front end load is mainly sales commission for the broker, plus some of that 1.5% expense ratio if they manage the mutual fund, and I have seen broker-managed funds that brazenly charge 1.5% expense ratio for an index fund).

Also, there is a fair bit of overhead per transaction, so investing so frequently and at such a low value as £50/month means transaction costs will be a worrisome fraction of the investment.

All in all, the various fees, loads and expense ratios are sapping you for half the gains your money actually did earn. This is stacking with your initial error, to make the gains look awful.

This is the financial services industry working as intended. It is designed to convince people not to think or learn about investing, convince them to blindly trust the industry, and then let them have a small amount of profit to think they're doing OK, while actually pocketing most of the real gains. There is a near infinite number of stupidly complicated products designed to snow investors and create more pretenses to sap a little more of your gains.

The mere fact that you're not going "oh cool, 10%" and going "hey, waidaminnit, 10%?" says these hokey products are not for you.


By contrast: open a Vanguard account: free. Transfer £50/mo. into eTrade account: free.

Buy VTI, a US ETF (simply because that's one I can attest, UK may have comparable): US $7 FREE per trade Because it's an in-house ETF. VTI earns in the robust US stock market, on average about 7% a year or 40% in 5 years.

Now, VTI is an exchange-traded mutual fund. Its front-end load is 0. Really. Its expense ratio is not 4%, not 0.4%, it is 0.04% a year. That is £1.20 a year on £3000. Really. So all the fees, loads and expenses over 5 years, will be about £6. All the remaining gains go to you.

VTI contains every publicly traded US stock. The fund makes no attempt to pick stocks, it simply buys them all. As such, its expense ratio is very low; as compared to the typical 1.5% of professionally managed funds that try to beat the average (and aren't likely to beat it by more than their expense ratio, so, a net lose).

The concept is described in John Bogle's book "Common Sense on Mutual Funds". Bogle founded Vanguard, creator of VTI. Several other companies like Fidelity and Charles Schwab do the same thing.

Try it like this. You'll do much better. I can't say I recommend US stocks right now but save your shillings - I think Wall Street may be about to have another half-off sale!

  • 14
    Or if you know you want VTI, open a Vanguard account and buy VTI or any other Vanguard ETFs commission-free (you still can't buy monthly, because you have to buy whole shares). Also make sure to opt into e-statements to avoid the annual account fee. – Ben Voigt Jan 3 at 5:35
  • Oh, thank you @BenVoigt ! Talk about improving an answer! – Harper Jan 6 at 16:40
50

One problem with looking at investments this way is that only £50 of your money was in the market for the whole 5 years. That last investment of £50 was only in the market for a month, and £600 of it was in for less than a year.

This makes it seem like your investment isn't growing very fast. To be able to see how it might grow I tend to use a spreadsheet, it lets me show separately how the value is growing year after year instead of just displaying a final number.

  • 23
    The average amount of money deposited the fund over the 5 years is £1500. £328 gain on £1500 is actually 22% gain, or 4.4% a year. As well as you can expect given Brexit... – Harper Jan 2 at 0:12
  • @Harper Though, the annualized earnings on it would really be higher than that, since well below the average amount was in the account early on - having longer to compound - while above-average balances were invested for a much shorter duration, having less time to compound. – reirab Jan 3 at 23:18
14

Patience.

Five years is a very, very short period of time. The gains in long term investing are much more significant in the 50th year than the 5th.

If you double your money every 10 years (a reasonable rate for many long term portfolios), you'll have less than 1.5x the original amount after 5 years. But after 50 years, you'll have 32 times your original investment.

  • 5
    You assume the author is about 20 years old and have some idea why he needs profit after 50 years. Maybe he will start living at 70, if he is alive and the investment is not lost for some reason. – i486 Jan 1 at 22:16
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    This answer is not wrong, but having patience does not negate the fact that OP is being presented with a really bad deal. With investment that is not a rip-off, sure, having patience helps. – void_ptr Jan 2 at 19:24
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You're looking at a 5 year period that does not show the impact of compound interest. This is a short time period thus limiting the impact of compounding. The risk set is not advantageous as there is little time to recover from a potential dip. This is noted under 'if the market performs worse' in the image. Investing is normally a long game.

To visualise the impact of extending the terms using a tool that includes a graph may help.

Secondly, you are adding up the total principal and treating the it like a return over a year. This makes comparison with anything else harder. Having tried to go backward from the figures, your rate of return is around 4.2% - 4.3%. While this may not seem like much, it is around 2-4x greater than you could get in a savings account.

Sticking with your £3000 principal and return of 4.2% :

  • in 10 years you will have made around £1608.
  • in 20 years you will have made around £4078.

(assuming stable conditions and that the rate of return averages out at the same level)

From a historical perspective, much larger returns have been possible. This is pointed out with the caveat that no-one knows if it will continue.

4

Other answers concentrated on how this specific calculation has weaknesses, and suggested ways of looking at it which can make you do a couple percentage points better or so. I would like to answer from a different angle: yes, this is good. Your expectations seem to be unrealistic.

What you are doing by investment is that you own something, and loan it to people who have a need for it. The price is determined by supply and demand, which in turn are driven by the total usefulness the lenders can get out of the loaned thing (in this case capital), the supply of it (how many others are willing to lend), the risk of not getting it back, and so on. When you invest in an index fund, you are safer than when investing in the shares of a single corporation, and you are tieing your funds to the performance of the economy as a whole, if you pick a sufficiently representative index.

Just think of your returns as a combination of inflation, plus growth of the economy you are investing in, plus a risk factor. That's when your money comes from. Inflation makes it possible for people to pay you more money, because it costs less. The risk factor allows people to pay you more money, because some other investor will get no money back, making the same total amount of money earned divisible among less investors. Economic growth is also a limit on what you get: if a company you lend to gets 5 pense of profit per pound of capital it uses, it cannot pay you 7 cents per pound you lend to it, and economic growth is roughly proportional to total profits made in the economy.

Now consider: how much does an economy grow? High growth is possible in some small economies which are experiencing booms due to globalization finally reaching them, or in those which are starting to recover from a low point due to war or natural disaster. Old, large, stable economies, with stable or shrinking population numbers, just cannot grow at huge rates. And in periods when they do grow better, there is also inflation speeding up.

So, if you imagined investing as a ticket to being a millionaire soon, no, this is not the case at all. What investment is good for is to make sure that your savings are not eaten by inflation during your lifetime, and that there is some increase in comfort you can afford in later years. That is already a very good thing, since people tend to take constant or slightly decreasing consumption levels quite badly. But it will not take you from middle class into daily caviar-and-champagne.

The whole idea that there is a widespread, passive, accessible way of increasing one's purchasing power above the average of other people around you is logically impossible. There are ways to become rich which are not accessible to everybody - if you solve a Millenium problem, you'll get to be a millionaire. There are ways which are not passive - if you invest enough workhours of your time doing the right thing, you can get rich, dependent on several other factors. But if anybody could just get money for doing nothing, everybody would suddenly start doing it, which would mean that everybody's purchasing power would suddenly go up, and a new average would be reached. You could of course get passively rich by loaning something very rare to others, say if you had an apartment building in the center of London. But if what you have is as common as a 50 pounds per month, then you get something in return for it, but not untold riches. The few people in the world who got immensely rich from investing, like Warren Buffet, had an immense combination of skill and luck, plus a lifetime of active application of that skill.

From that point of view, there is nothing wrong with the returns you described. You can fine-tune them, but not turn them into a gold mine. And there is nothing wrong with that.

  • "Old, large, stable economies, with stable or shrinking population numbers, just cannot grow at huge rates." True. But the rates in the question are still pretty bad. I'd say the U.S. certainly has counted as a "large, stable economy" over the last century and the S&P 500 has averaged an annualized return of around 10%. Not 10% in five years, but 10% in one year. And this should be with significantly less risk than the "adventurous" setting described in the question. – reirab Jan 3 at 23:24
  • @reirab I agree that the OP can get more than what this calculation shows. My point is that, even with a better return, "investing is the way to multiply wealth" is an overconfident way of stating it. Sure, this investment scheme could bring 500-600 pounds instead of only 300, but especially with inflation and taxes, it is not going to suddenly make the OP rich, which seems to be the expectation, at least from what the tone of the post suggests. – rumtscho Jan 4 at 11:17
  • I'd agree that investing (normally) won't make you rich overnight, but, over long periods of time, it does add up significantly. For example, if someone with a median income in the U.S. retired today and had been able to put 12.5% of their income into S&P 500 index funds instead of paying it into Social Security, they'd most likely be a millionaire (the fund alone would be $960,000.) Even if they converted that to something with a relatively low 5% annual yield, they could live off of the interest alone and get far more than SS would provide. – reirab Jan 4 at 16:34
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When you add a fixed sum every month, the calculation is a little more complicated than what you did. If investing 50 always results in 50*r at the end of the month, then the sum of s=50*r^(60-i) for i=1..60 is the value of your capital after 5 years. You can set s=3328/3000 and solving for r you can get the true rate of return, which I found to be about 1.00375. This is per month - it is more common to discuss yearly rates, so you are getting r^12=1.046 per year. That's a 4.6% return, so not that bad. A common benchmark is S&P, which is said to return 7% pre-tax "in the long term" (actual performance of the S&P varies quite a bit). Keep in mind though that the S&P is indexed in USD, so when using it to benchmark your GBP investment you have to factor in the USDGBP exchange rate also. Furthermore, I'm not sure what wealthify actually invests in, but the S&P is an appropriate benchmark for investing in US stocks. If investing in UK stocks, a UK index might be more relevant as far as measuring whether you're getting "enough" out of the market.

So in conclusion, this is a reasonable rate of return. It's a bit less than what you could get if you bought shares directly, but then you are getting this for zero effort on your part, so the middle man is expected to take a cut (after all, Wealthify is not a charity). It is also important to consider risk, but your image does not say much about that. The projected values are not useful without at least a probability attached to them. Ideally, you want a probability distribution of every possible value, not just 2 or 3.

Also, if 50 pounds is indeed what you have to work with, investing is probably not worth the trouble. Use that money to pay off your credit card, car loan, bills, and build a rainy day fund. Don't fall into the trap of thinking you're immune to bad luck, and will never have emergencies. Emergencies can be very costly when you don't have cash on hand (for instance, see your credit card's late payment fee), and simply avoiding those costs will save you more money than this investment will likely produce. If 50 pounds is all you have at the end of a typical month, I'm guessing you're wasting a lot of money in late/overdraft fees on your credit card, bills, bank accounts, loan payments, etc.

0

Wealthify tells you you will have pretty low interest. I suggest ditching it and investing in index funds.

According to my calculations if you invest 50 pounds (or any other currency, it doesn't matter) for 5 years each month and you have 3300 pounds at the end of that fifth year, it means you had an equivalent of 3.75% yearly interest, which is pretty low. I expect about 9% average yearly interest with index funds.

In comparison using the same calculations with 9% average yearly interest you'll have 3760 pounds.

I don't know if you can invest in index funds using such small portions of money as 50 pounds, but you should check.

Code of the program I used for my calculations (in Python 3):

interest_per_year = 0.0375 # 3.75% yearly interest

# transform interest per year to interest per month
interest_per_month = (interest_per_year + 1) ** (1/12) - 1
print(interest_per_month)
money = 0

for month in range(12*5): # for each of 12 months in each of 5 years
    money = money + 50 # you add 50 dollars each month
    money = money * (interest_per_month + 1)

print(money)
0

The amount of money you have in the stock market doesn't determine the rate of return you will get. Doesn't matter if you have a billion dollars in the stock market or 50 dollars, your rate of return will be the same.

The s&p 500 is suppose to go up 1% and yields like 2.5%. High interest savings accounts are yielding 2%. Anyone that tells you that you can build tons of wealth by investing in the stock market in this low interest rate environment is delusional.

Since you don't have tons of cash, It would probably better for you to pay down debt or buy things that would save you money in the long run. Like buying things in bulk.

Good compound interest calculator: https://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php

protected by Chris W. Rea Jan 4 at 1:16

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