Dover encourages direct share investments.

In a post FOFA fee for service environment the first step in creating a viable and sustainable fee for service practice is to actually provide the service, not refer it off to someone else. In this context “the service” includes regular advice on specific share investments, with an emphasis on long-term positions on blue chip shares.

Financial planners are competent to provide this advice.

Dover discourages advisers from recommending indirect share investments through actively managed funds. There are two reasons. The first is that there is substantial, repeated evidence that active management does not pay for itself in terms of generating additional returns that (at least) offset the higher fees caused by active management. The second is that we prefer our advisers to do this work, and get paid for doing it. We do not see the point of referring your client and your future profits to a third party. In particular, we encourage advisers to provide this investment advice for a fee that is less than the management fee that would be paid to a fund manager for active management. This means, of course, that the client benefits by an overall reduction in fees paid in relation to their investment.

Remember, if a client can be shown how to reduce their investment fees, the client gains. Fees reduce investment returns. Where an adviser can assist a client to achieve the same gross return for a lower overall fee, the client is clearly better off. 

Advisers should:

  1. carefully select a legal structure for the client’s share portfolio, typically a SMSF, a trust, a company or a combination thereof
  2. choose no more than 12 blue chip Australian shares
  3. ensure sensible minimum holdings: this depends on the client and the overall size of the portfolio, but in summary $25,000 is usually a sensible minimum holding
  4. ensure a minimum holding period of ten years, and preferably much longer and
  5. insist on regular 6 monthly meetings to provide research up-dates on each share and to review the overall performance of the portfolio.

One common error: too many small dollar value shares

One common error involves recommending too many low dollar value share holdings. For example, we recently reviewed a statement of advice where the client held about $200,000 of shares in her own name, with more than thirty individual shares.

The average holding was about $6,000. Some holdings were as small as $1,500.

This is inefficient for at least three reasons:

  1. transaction costs, research time and accounting fees are too high
  2. probability theory means her results will probably reflect the average of the market over time, which means the client is better off investing in a low cost index fund and
  3. there is no possible plausible reason for holding a security with a value as low as $1,500.  It generates as much time and trouble as a $150,000 holding, for virtually no return. It does not make sense.

Probability theory says this client will probably get an average return. She could have got that holding a simple index fund, without the extra time, cost and trouble.

A client should only hold direct shares in the expectation that holding those shares will deliver an above-market average return. In this case, the client would have better prospects of generating a return greater than the average market return if she had no more eight shares, with no more than $25,000 in each holding.

This portfolio costs less to hold, is easier to manage and has better prospects of beating the market. It does make sense.