Good reads from around the Web.

Are you a prudent saver who regularly runs the numbers on your potential post-retirement income?

Or are you a Scrooge McDuck who has fallen in love with money for its own sake?

The title of a John Authors’ article in the FT this week – Is Greed Good? No, It’s Seriously Bad For Your Health [Search result] – implies that this isn’t an academic question.

Authors even cites research suggesting it’s not just your physical health that could suffer from an excessive love of money, but also your financial health.

He writes:

Psychologists now have a clear definition for love of money. It is not about any instrumental need for money to fulfill our other goals, which all of us have, but rather about a love or need of money for its own sake.

Using the Money Ethic Scale developed by Thomas Li-Ping Tang in 1992, State Street developed an Investor Love of Money Scale (ILOMS).

Researchers asked interviewees in 20 countries a series of questions designed to find out how important money was to their self-esteem.

They also tested how they would respond in a series of financial situations.

For example, they would ask if money was a symbol of success, if they talked about it a lot, or if they wanted to be rich.

The results were clear. The more someone had an emotional attachment to money, the more likely they were to make mistakes with money.

A series of behavioural biases that lead investors into predictable mistakes have been diagnosed over the years. Avarice exacerbates all those biases.

The article goes on to list investing vices, from over-trading to buying high and selling low.

Being in love with money could be counter-productive, in other words, even for intentional money-grabbers.

Money, money, money

It’s a nice morality tale and life is more complicated, but I do agree that concentrating on wealth can at least change you as a person.

I’ve seen a bit of that in myself.

When you first start saving and investing, the idea that you’re in love with money feels fanciful.

Unless you inherited the family pile – literally – you start with nothing (or these days likely less than nothing, after student loans).

You’re just trying to be sensible, at a time when money is scarce, too.

However as the years go by, your wealth grows and snowballs. At some point it becomes so much that when you’re adding the sums up you’re looking at quite a wodge.

And you wonder.

Of course, you probably rationalize this wodge away – as I believe you should. It’s for financial freedom or to keep the lights on in retirement. Your friends might not nurture their nest eggs to the same degree, but they face the same challenges and have likely stashed some of their cash, too.

Being conscious of these challenges and actively trying to confront them doesn’t seem like the same thing as being in love with money to me. The FT quote I highlighted above agrees.

Then again, I know that in my 20s I seriously didn’t care much about money.

I saved it because I am by nature a saver.

But I earned a relative pittance compared to my university peers and I rarely thought about it.

I considered gambling away ALL my life savings in a business venture in my-mid-20s – and I did put about half of them into one in my early 30s.

I can’t imagine taken such proportionate risks with my wealth barely a decade later. Have I fallen in love with money?

I don’t think so. Rather, I know I’ve gotten older and I believe there’s less time left to make good.

That said, unlike most Monevator readers I have probably fallen in love with active investing and with keeping score.

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Good reads from around the Web.

I was not shocked to read this week that Jim of the SexHealthMoneyDeath blog has gone back to work.

It was obvious he found being retired early pretty boring. I was surely just one of many who suggested he should “get a job”, in kinder tones than that might be uttered.

Jim confessed:

I was struggling a bit with the retirement lifestyle, and finding the change from a full-on, full-time working week to a zero-hour one quite difficult to handle.

I just couldn’t shake the notion that I was too “young” to put my feet up, that I should be working and that I should be out there earning money.

I might not have “needed” the latter, but it never quite felt that way.

Few of us are really frustrated artists, office-caged adventurers, or wondrous philanthropists desperate to be out in the community doing good deeds for free instead of paying the mortgage.

Most of us are social creatures who like fitting in with the Joneses, even if we manage to shake off the urge to keep up with them.

And in our society, that involves somehow making money.

Even as a self-styled bohemian investor, I am fairly confident I’ll not give up entirely on “doing stuff for money” at anything younger than 80, and with luck and health not for a while after that.

On this planet, in this era, and with my mindset, it’d probably be easier to give up wearing clothes.

Many of you feel differently, of course. My co-blogger The Accumulator and I have debated this endlessly.

But I believe almost everyone will benefit from having an ongoing economic relationship with society while they can – even if only for a day or two a week.

Sadly, by the time most people reach the point of having options, they seem to feel too burned out by the workplace to explore all the various other ways of making money more freely.

If you can do it, you probably won’t

Personally, I think gaining financial freedom – the ability to say “no” to any boss or client, and to walk – is a truly worthwhile goal, but that retiring early will often prove a pretty futile outcome.

I think that’s especially true for the few who will be able to achieve it these days under their own steam.

That is, not the old 1990s way of being retired early by being shuffled out of a firm on a hefty company pension aged 55, but rather the modern, self-made save hard and invest like fury – or start a successful business or lucrative side-hustle – way.

Few people who can do that want to watch Pointless every afternoon waiting for their friends and family to finish work or school.

I know, I know, you will begin early retirement by doing an Open University degree course in archeology while making great strides in hybridizing apple trees in your back garden and teaching disadvantaged children Esperanto in your local youth center.

But most people won’t have your imagination…

So it’s no surprise to me so many high-profile personal finance bloggers who retire early go back to work – or never actually stop working.

Anyone who can create a very successful blog while generating enough money to retire at 45, say, is likely to be bored to tears by doing nothing – however much “doing nothing” is disguised by the flowering of (supposedly) constrained passions, travel, family life, or the gentle slide into somnolence.

Incidentally, I also think retiring early is bad for your health.

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Commentators often describe index trackers as plain and simple vanilla funds, benign enough for even the most inexperienced retail investors. But in reality, the investing industry is a hothouse of evolution, continually breeding products that pass themselves off as cuddly trackers, but which can conceal retractable claws.

The following product types may all be classed as index trackers, although I only use the term to describe index funds and ETFs in my Monevator articles.

These other varieties are weighed down with features and risks that need to be properly understood before you dive in.

Index funds

The most straightforward tracker type of all, low-cost index funds should be first choice for inclusion in your passive portfolio. Index funds:

• Generally invest in a diversified range of equities or bonds.

• Physically own the assets of the indices they track – though the fund may only own a sample of the index.

• Are open-ended so their price closely matches the underlying index.

• Trade once a day.

• Don’t incur trading costs when bought through a percentage fee broker.

Physical ETFs

Physical Exchange Traded Funds (ETFs) are very similar to index funds except that:

• They’re traded on the stock exchange, through brokers.

• You can buy and sell ’em throughout the day like shares.

• They incur trading costs, so are more suitable for larger investment sums.

• Huge product diversity lets you fine tune your portfolio.

Synthetic ETFs

Synthetic ETFs are riskier and trickier than physical ETFs. They should only be used if you fully understand the differences between the two.

Synthetics trade like physical ETFs, except:

• They don’t actually own the assets of the indices they track.

• Instead, they buy a total return swap. That’s an agreement with another financial entity to pay the ETF the return of the index.

• The ETF is exposed to counterparty risk if the swap provider defaults.

• European regulations limit the exposure to 10% of the ETF’s net asset value.

• Collateral should cushion the ETF from counterparty disaster.

Investment Trust trackers

There aren’t many of these beasties about. They’re quite similar to physical ETFs in that they’re:

• Listed on the Stock Exchange.

• Bought through brokers.

• Traded in real-time.

The additional complication with Investment Trusts is that they are closed-ended funds. They have a fixed amount of shares in circulation, so the trust’s price at any moment reflects supply and demand for the fund itself, as well as for the underlying index. Investment Trusts can therefore trade at wide discounts to their net asset value and sometimes a slight premium. You can lose or gain on an investment trust as the discount fluctuates, even if the index remains absolutely flat.

ETCs – commodity or currency tracking

Exchange Traded Commodities (ETCs) can track everything from gold to leveraged lean hogs but they’re not as straightforward as their ETF namesakes:

• Only a few precious/industrial metal ETCs can afford to physically hold commodities, which enables them to track the current (spot) price.

• Most ETCs track their commodity’s futures market. Returns on futures differ from returns on spot prices.

• Some ETCs track single commodities, others a broad basket.

• ETCs are structured as debt instruments to avoid UCITS rules on diversification.

• Investors are exposed to counterparty risk (up to 100%).

• You don’t get dividends.

Exchange Traded Currencies are similarly structured and track the foreign exchange fluctuations of pairs of currencies.

ETNs and Certificates

Exchange Traded Notes (ETNs) and Certificates are cheap and potentially nasty. There are many variations on the theme, but basically they track an index, are tradeable on the Stock Exchange, and:

• They’re debt instruments issued by a single party (normally a bank).

• The bank agrees to pay the return of the index on the product’s maturity date.

• The underlying assets are not physically owned.

• If the bank goes kaput you’re in trouble.

• Counterparty risk exposure is up to 100%.

• They’re a low cost way to enter hard-to-access markets.

• Tracking error is low – it amounts to just the fees.

Structured products

There’s a whole soup of structured products out there that are labelled as trackers. Normally they’ll follow an index of some sort and lure investors with alchemical promises of outsized returns and capital protection.

Broadly:

• They’re close ended.

• Have a finite lifespan.

• Capital protection is only offered if you hold for the full lifespan of the product.

• The return is provided by derivatives.

• It’s counterparty risk time again.

• You give up your dividends.

• You’ll scratch off your scalp trying to fathom how they work.

• There’s no free lunch!

What you track matters mightily

Just because you’ve invested in the kind of fund you’d happily take home to meet your mother – a traditional index fund or physically-replicating ETF tracker – that doesn’t mean you’ve necessarily bought a vanilla fund in terms of the exposure you’ve taken on.

I’ve described the different tracker type vehicles – but I haven’t got into the passengers in the vehicle, or where you hope it’s going.

An index fund may seek to track a mainstream index like the FTSE 100 index of the UK’s largest companies, the S&P 500 in the US, or the entire global stock market.

But innumerable funds are available that seek to track all sorts of other weird and wonderful indices (and yes, “weird and wonderful” may be considered a euphemism for “odd and unsuitable” for us passive investors).

I’m thinking about specialist indices creating in-house by fund managers to track niche sectors – companies involved in robotics or selling to teenagers or global arms, say.

These products might have their place for thrill (/loss…) a minute active investing sorts, but they have nothing to offer us sober passive investors.

You might also come across ETFs that aim to, for example, double the daily upside or downside of the index being tracked. Again, back away slowly.

More respectable from our perspective are funds that track indices dedicated to winkling out the potential return premiums from certain cohorts of shares (sometimes called Smart Beta funds) that focus on value, profitability, and similar factors, where you might hope to boost your annual returns by a percentage point or two over the long-term.

But such funds have extra risks and other downsides, too, so make sure you do your research.

Just remember the type of index tracker you plump for is one thing – but the index being tracked is a separate matter.

Take it steady,

The Accumulator