Sunday, October 6, 2013

Why I don't like Nutmeg

Nutmeg is a startup that provides investment management for consumers. Basically, when you sign up with them, they'll ask you some questions to figure out your risk tolerance, timeframes for investments, how much you want to pay-in each month etc. They will then go and buy investments (stocks, bonds, REITs etc.) for you and manage your portfolio on behalf of you (i.e. they will buy/sell your assets on their discretion).

They charge up to 1.0% for this asset management piece depending on the amount of asset you have with them etc. This doesn't include the cost that the assets incur themselves which they say is on average about 0.3%.

So why don't I like it?

1.3% is WAY too expensive

Before I can explain why 1.3% is too expensive, I have to quickly touch on the two different investment strategies, Passive and Active.

Active strategy is what most of us usually think of investment strategies. In an active strategy, you'd sit down and think about what to buy. For example, you might go "Now that Ballmer is gone, I bet Microsoft will be way more successful in the future", and thus buy Miscrosoft stocks. Or you might go "I think Chinese stocks are way overvalued these days" and sell some Chinese stocks.

The key here is that you are trying to predict the future and/or outsmart other investors. You predicted that Microsoft will do well and that's why you are buying their stocks. You think other investors are overvaluing Chinese stocks, and that's why you are selling them.

This is obviously hard work and requires ample experience, and this is where companies like Nutmeg come in. They'll do this work for you, and in turn you pay them the 1.3% fee.

In the world of Active investment strategy, 1.3% isn't necessarily expensive. The problem however, is that if you are an average consumer, you won't need Active strategy. There are people who disagree with this (usually fund managers, stock brokers etc.), but the evidences are overwhelming. A recent study by S&P for example, which examined 10,000 actively managed funds, found that 82% of them underperfom passive funds (source).

Warren Buffet, the legendary investor has also stated:

[...] most investors are better off putting their money in low-cost index funds [...] very low-cost index is going to beat a majority of the amateur-managed money or professionally-managed money [...] gross performance [of actively managed funds] may be reasonably decent, but the fees will eat up a significant percentage of the returns 

And put his money where is mouth is. He specified his personal portfolio after his death to be invested in low cost index funds (source).

Really, there is very little reason for an average consumer to go with active investment.

Believe me, it's not hard to do investment yourself

A couple of people have told me "Well, but I don't want to spend any time thinking about my investments. I'd rather just pay 1.3%". They probably don't realize how big the impact of these costs are in the long term.

[...] illustrates how strongly costs can affect long-term portfolio growth. It depicts the impact of expenses over a 30-year horizon in which a hypothetical portfolio with a starting value of $100,000 grows an average of 6% annually. In the low-cost scenario, the investor pays 0.25% of assets every year, whereas in the high-cost scenario, the investor pays 0.90%, or the approximate asset-weighted average expense ratio for U.S. stock funds [...] The potential impact on the portfolio balances over three decades is striking—a difference of almost $100,000 (coincidentally, the portfolio's starting value) between the low-cost and high-cost scenarios

Yep, they call 0.90% "high-cost scenario". 1.3% is really high, and it will cost you a lot.

Asset allocation (i.e. deciding what to buy, what to sell) is very simple in Passive investment. Vanguard, an investment firm that pioneered Passive investment has generally good resources to start, for example this guide. Here is another good starting point from Forbes. These kinds of dead simple portfolio are the ones that "consistently outperforms most actively managed funds" as noted earlier. Once you decided on an asset allocation based on the return you want, the only thing left really is to find the cheapest mutual fund/ETF that tracks that asset class and buying it.

If you are still too lazy to choose your own asset allocation, you can buy "balanced funds", which are mutual funds with pre-made, low-cost index asset allocation. Here is a collection from Vanguard. Note the expense ratio. The lowest one has 0.1% while the highest one has 0.18%. Yeah, compare that with 1.3%.

These "balanced fund"s have in general a very simple asset allocation, and hence it's easy to just copy the allocation. In fact, there is even a tool for that online. This will give you an even lower cost, but the downside is that you'll have to do asset rebalancing yourself whereas "balanced fund"s will do that automatically for you.

So yeah, that's why I don't like Nutmeg. The world needs more passive investment, not active.

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