Some people find complicated financial products compelling. Especially financial advisers peddling a hot new fund for commission.

If there’s a whiff of the exotic thrown in, so much the better.

A person who knows nothing about Indonesia, Brazil, or South Africa will confidently tell you that these countries offer much better returns than the domestic market.

Ask them why and they’ll point to our aging population, political sclerosis, or rising public debt.

Typically they know nothing about the problems of the alternative countries. It’s just that the exotic unknown is more attractive than the all-too-familiar reality at home.

Sophisticated isn’t complicated

Overseas investing is a good idea, sure.

But that’s as part of a diversified portfolio, not as a punt on crackpot Internet theories about the demise of the West.

Other people assume complex products and ambitious strategies must be superior to a tracker fund.

Why shouldn’t they be? More expensive computers are better than cheap ones. Famous lawyers are superior to also-rans.

But investing is counter-intuitive. Paying more usually means worse results, because active investing is a zero sum game where the only certainty is higher fees.

Typically the investors they attract will waste money paying for a poorer performance from funds that promise to outperform, or else from absolute return funds that cap returns and rake off the upside but don’t entirely protect the downside.

At worst, they’ll put money into the next Bernie Madoff-style Ponzi scheme.

They hear other clever people are doing so, and the fact that it’s a black box makes it more attractive to this kind of mindset, not less so.

We all love mysterious strangers

Generally however, it’s best to keep things simple when investing.

When you become more interested in wealth preservation than in growing your nest egg you might try some risk-aversion strategies.

But in your core saving years a simple ETF portfolio is probably your best bet.

Whatever you do, avoid rushing into exotic funds just because they sound sexy.

Of course, nobody puts money into something just because it sounds sexy. That would be dumb.

No, rather like a country maiden stumbling into the path of Don Juan, they fall for the sexy talk:

• The fancy brochures or snazzy website
• The impressive back-tested returns
• The puffy articles in the financial press
• The high-blown talk of commodities or futures or frontier markets
• The nifty name dreamed up by a guy with a cool hair cut

Most of this stuff is just pretty words.

There’s nothing really new under the sun in investing. If complicated strategies were better, we’d know already.

What we do know, rather, is that passive index tracking is usually best.

The unfamiliar is appealing

It’s too easy to be swayed by the superficially different.

I was reminded of this by a recent advert from the oil producer Shell. It portrayed a camera-friendly Japanese family going about their life of burning fossil fuels and polluting the planet.

Obviously the ad focuses on the domestic end of this particular value chain, mind you – all hugs and home furnishings.

[Update: I used to have the advert embedded here but the video has been taken down in the years since publication. Fashion changes, eh?]

I loved this ad when I first saw it. The combination of exotic location, mysterious utterances, and its surging guitar riffs made my spine tingle.

You can imagine my disappointment then when I did a bit of research via Google and found the truth rather duller than the fictional reality.

What does the protagonist Mr Ohashi utter to his wife, I had wondered?

“I fear the return of Godzilla,” perhaps? Or maybe: “Will this day end in darkness?”

No. He just says about his son: “What is he doing?”

And what about the sage, sweet murmuring of his wife?

She says: “It’s because he’s a kid.”

Not much poetry in that.

Finally, I used Shazam to discover who recorded the guitar riff.

I expected to discover some incredible Japanese hardcore band, but it was actually recorded by a U.S. novelty group called Green Jelly.

Even worse, it’s just a version of the children’s song The Bear went over the mountain, to see what he could see. (He sees the other side of the mountain…)

Don’t believe the hype

If this advert was filmed in rainy Croydon, in English, with the music rattling only a pair of ancient Charles and Di wedding mugs and the tune replaced by Slade singing Humpty Dumpty, then nobody in Britain would fall for it.

Perhaps that’s the version they show in Tokyo?

Think about it the next time you’re tempted to put money into some complicated, exotic sounding financial product on the back of its mysterious charms.

This is part of my series on why borrowing to invest is usually a bad idea.

A mark to market investment is one where the price of a security (or a company or other recently valued asset) gives an accurate appraisal of its current financial worth.

For instance, a company’s share price tells you what buyers are prepared to pay for it right now. We can call this the market price.

The company may own assets in excess of the value implied by its share price, but the company’s valuation is marked to market by what traders are currently willing to pay for its shares.

Value investing involves looking for assets that are worth more than their market price. It requires patience, because it can take time for value to be ‘outed’ – that is, for the market price to tally with the company’s true value.

Mark to market, mortgages, and borrowing to invest

One reason why using a mortgage offers the best hope of making the maths work if you borrow to invest is because mortgages are the cheapest form of debt.

But another key advantage of a mortgage is that your house and your debt is not marked to market.

This means that if the Daily Mail reports house prices have fallen by 10%, you won’t be expected to stump up an extra £30,000 by your bank.

i.e. You won’t face a margin call to avoid being kicked out of your house just because your house’s price has fallen while your debt is unchanged. Negative equity only matters if you need to sell and you can’t repay your mortgage.

If you have a mortgage while investing in equities then you are effectively borrowing to invest, because the money you use to buy shares could instead be used to pay off your mortgage.

Most of us do this, if only because we have pensions. We get away with it because any declines in our share portfolios don’t force a margin call on the mortgage on our homes.

Indeed, some people go a step further by using an interest only mortgage to try to invest their way to repaying the capital they owe their bank. This is much riskier, as there’s no guarantee their investment will grow sufficiently large to cover the outstanding capital payment on the house at the end of 25 years.

Mark to market and spreadbetting

In contrast to a mortgage, a spreadbet is a good example of a mark to market loan that can be extremely expensive if you can’t meet the margin calls, let alone all the other magnified risks of investing with borrowed money.

With a spreadbet, you put down say a 20% deposit to trade a particular share on margin. The other 80% of your holding is bought via a loan. (The interest cost is wrapped up in the ‘spread’).

For example, let’s say you want to take out a £1,000 position in a share via a spreadbet. You put down £200 (20% of £1,000) as you place your bet.

Now imagine the share price drops 10%. Your position is now worth £900 — and you’ve lost £100.

You will therefore face a margin call to maintain your 20% deposit ratio, which means the spreadbetting company will immediately ask you to add extra money to top up your position.

In this case you’d need to add £80 to get to £180 (20% of £900) to stay invested.

Given how volatile equities are, such mark to market factors can easily kill your bet. You will either face a margin call or be kicked out of your investment when prices fall, and if you do sell then you’ll likely be too slow or scared to get back in before prices rise again.

Equities are too volatile for short-term borrowed money

When you borrow to invest on margin, you are at the mercy of the short-term. Yet the volatility of equities can only be tamed by taking a long-term view.

Spreadbetting is therefore risky not only because you are borrowing to invest and might lose money you don’t have, but also because mark to market can shake you out of positions that go against you in the short-term, even if your long-term call is good.

No wonder more than 80% of spreadbetters lose money.

We discussed above how your bank won’t bother you if property prices fall provided that you keep paying your mortgage.

That your bank doesn’t think it’s worth the risk to give you the same terms to invest in equities should set alarm bells ringing about the wisdom of borrowing to invest!

Footnote on spreadbetting

It is possible to spreadbet in shares fairly safely, if you reduce or entirely avoid leverage (debt) by offsetting your spreadbet portfolio with an appropriately sized cash savings account. You might do this to avoid Capital Gains Tax, for instance. It’s a fiddly subject, though, and one that will require an article in its own right. Watch this space!

My regular roundup of the week’s best reads.

The US blogger Barry Ritholtz says US houses are still significantly over-valued. That would be bad news for everyone, given that the US consumer is vital for a global recovery.

Unlike in the UK, house prices in the US did actually go pop a few years ago. They stayed down, too. And not just in the sub-prime bayous and inner-cities, either, but across the board.

In fact, I’ve wondered if I’d be tempted to buy a US investment property were £1 pound still worth $2, as opposed to the $1.50 it currently gets you.

According to Ritholtz, buying now would be a big mistake:

Today, residential real estate confronts numerous headwinds: Credit, once given to anyone who could fog a mirror, is now tight. Hence, demand is far below what it was during the past decade. Home prices are still unwinding from artificially high levels, and remained over-priced. Inventory is elevated. Unemployment remains high. A huge supply of shadow inventory is out there: Speculators and flippers who overpaid but have held onto their properties await modestly higher prices to sell. Bank owned real estate (REOs) continues to increase. We are barely halfway through a decade long foreclosure surge.

This is known, or at least should be by those who have looked at the data. I cannot explain why some economists still have not figured this out.

In my analysis, price stands out as being the prime mover of the next leg down. High unemployment, and a decade of flat wages aren’t helping to create any new housing demand. And the millions in homes they cannot afford will eventually add more pressure to inventory and prices.

It’s prices-to-rents that I nowadays find most interesting. (The alternative, price-to-earnings, has been trending higher for decades, after all).

Ritholtz offers the following graph:

While this graph does suggest house prices still have a little way to fall, what strikes a UK reader is the magnitude of the correction that’s already taken place.

Here in Britain house prices have already partly bounced back, with Santander this week reporting that there are still five times as many property millionaires as a decade ago:

While the credit crunch led to over 43,000 homes losing value and falling below £1m between 2008 and 2009, the statistics now show a recovery in the market for million pound properties.

Over the past year alone, the number of properties valued at £1m or more rose by around 29,000, boosting the number of property millionaires – the owners of these properties – close to the early 2008 peak when there were 147,000 of them.

Having barely wobbled and rebounded in London, UK house prices remain significantly elevated according to The Economist. Using the same price-to-rent analysis as Ritholtz applies to US home values, it said in April that UK house prices are 30% over-valued.

The snag? A price-to-rent analysis has been concluding the same thing since 2004, as some of us know to our cost.

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