Taking Stock / The make or break 2%
Moshe's friends read here recently about his first year of investing in a non-bank training fund (keren hishtalmut), and they almost burst from laughing.
"The whole story is 2 percent?" one sneered. "Your great move in taking your money out of the banks and putting it into another fund, got you all of 2 percent more yield?"
Another buddy who dabbles in stocks was even more scornful. "I hate to tell you, Moish, but a good ride on the stock market can get you 10 percent or double or triple that," he shrugged. "You're chasing your tail."
Moshe heard them out but didn't get bothered. He knows all about those rides on the stock market. He's been watching the capital market for 20 years and he knows that the ones riding the market are the big shareholders in the big companies and the brokers cutting their creamy coupons.
His experience has taught him that few people really know when to get in, and get out. To really gain from the market, you have to stay in all the time, because sometimes a month or two generates the same yield as the preceding five or ten years.
As for that pitiful 2 percent that his friends mocked, Moshe remembers that he also used to hold numbers like that in scorn, until he did the math.
Look at the table below. Moshe knows this table. It shows the power of small numbers like that "pitiful" two percent.
Say that Moshe, at age 35, has NIS 500,000 in savings. He sets aside NIS 2,000 a month, in a training fund, or insurance policy, or mutual fund.
How much will he have at age 67? That depends how much his policy is yielding.
If his long-term savings plan yields 3 percent net a year, at the end he'll have NIS 2.6 million. But if the yield climbs by 2 percent, yes, that measly 2 percent, he'll have NIS 4.4 million. Another 2 percent lifts his pension to NIS 7.5 million.
The reason is simple: compound interest. The longer the savings term and the bigger the yield, the more the sum grows.
Optimists may prefer to build a stock-based long-term portfolio and hope for 9 percent a year, and if they get it, they'll have NIS 13 million by age 67. Indeed, in the last year U.S. stock portfolios yielded about 9 percent to 10 percent in the last decade, and if you think history portends the future, you might want to increase your exposure to shares.
Assuring a comfortable future
Several conclusions arise from the tremendous difference that small numbers can make.
The first is trivial. Each 1 percent is worth money, each 2 percent is worth a lot of money and they are worth making an effort over.
The second is more complex but no less important. Experience teaches that very few investment managers manage to beat the market over time. It is very hard to predict who will manage to pull it off in the future. A person's record says nothing about his future success.
This is where management fees come into the picture. Since it is hard to beat the market over time, and differences of a few percent can make tremendous differences over the long-term, management fees can dramatically affect the outcome.
That explains why index-based funds have been sprouting like mushrooms in the last decade. These are passive funds. They do not pick stocks, they buy a market-based portfolio. As no effort is expended on management, they can charge low fees of 0.25 percent to 0.5 percent a year, compared with the amounts of 1.5 percent to 2.5 percent at active mutual funds. At this stage you have grasped the significance of the difference, over time.
In Israel, the situation is a bizarre one. Even though the privately-run provident and mutual funds charge significantly higher management fees than the bank-run funds, they manage to achieve better net yields.
How? A combination of clumsiness and bad management at the bank funds adds to the technical advantage of the brokers' funds, which are smaller and nimbler, and which are also starting to take in massive sums of money from savers.
How long will that pattern persist? It is hard to say. But the more money passing from the banks to the brokers, the harder it will be for the brokers to enjoy their advantage of small-size, and the harder it will be to implement creative management that results in vehicles outperforming the banks.
Israelis may yet discover what America's investors have long since learned, as they shift their custom to the passive, index-based funds. Small percentages can mount to big numbers, and lowering management fees is sometimes the main way to achieve good yields over time.