MTTM Podcast 87: Which emotion is driving the stock market, Mortgage calculator sham & The fund charge ruse

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The Market Fear and Greed Index

This is a great tool and anybody can use it for free. This indicator judges which emotion is driving the market, fear or greed. It shows a scale between zero and 100 where zero means investors are running scared and 100 means investors are being driven by greed.

The tool is called the Fear and Greed Index and it is run by CNN. The Fear and Greed Index is actually seven indicators rolled into one and it gives you a snapshot of what emotion is driving the market.

The theory is that if the markets are being driven by fear, then too much fear in the market will mean that stock markets will fall. Just think about after the 2008 financial crisis where everybody was running for the hills and scared. Of course, if it's driven by greed, everyone's being very bullish and therefore they are buying up stocks and this will drive the market up. It's the simple economics of supply and demand. More people wanting to buy, the price goes up.

Interestingly, there's a nice angle for people who are trying to be contrarian investors. Contrarian investors will take the opposite view to most of the market. If everyone is being bullish, they might decide to be fearful and vice versa. There's a famous quote by Warren Buffett, to paraphrase it, it is "When others are being greedy, you be fearful." And the other way around, "If people are fearful, you should be greedy."

So the idea being that when everybody is running for the hills, that's a brilliant time to buy, because you have to be pretty brave to do it. But if you go in, you're going to invest in things at rock bottom prices. Then when the market reverts to mean and it rallies again you're going to make a killing. Given that Warren Buffet is probably the most successful investor in the history of investing it's not a bad piece of advice to adhere.

If any investor can catch the bottom of the market they are going to make a hell of a lot of money and that's what contrarian investors are trying to do. They are trying to take the opposite view with the aim of catching the market turn.

Let me now go through the seven indicators that make up the Fear and Greed Index. The first one is something called stock price momentum, where, very simply, they take the S&P 500, which is one of the American equity indices, and they look at it versus the 125-day moving average. They look at the trend over the short-term versus the slightly longer term, so they can see where the momentum is; is it going up or down?

Another indicator is known as stock price strength, which is, quite interesting, as they look at the number of stocks that are hitting 52-week highs versus those that are hitting 52-week lows. The idea being that if more stocks are hitting highs than there are stocks hitting lows it's a better indicator of where the market is going and what the sentiment is, as opposed to just looking at the index price movements. This is because the market index could just be going up because of its market capitilisation bias. As many indices are market cap weighted the biggest companies have a disproportionate impact on the value of the index.

Another indicator is called stock price breadth, which looks at the number of shares trading and the number going up versus those that decline. So you actually see what people are buying.

There's another indicator called put and call options which looks at the trading volumes. Basically, put and call options are used by traders to lock into future prices. They might buy something now and then agree a deal with somebody else that they can actually sell it at a higher price or a lower price in the future. We talked about it once before on a previous podcast where there were loads and loads of people who, effectively, were betting that they thought the market was going to fall and it didn't. Of course, then they had to all unravel their bets and this actually drove the market up. It's called a short squeeze.

I'll just rattle through the rest of the indicators. There's one that looks at the activity in the bond market particularly junk bonds. If a company wants to raise money, they can do this in a number of ways. It could be by issuing shares, or they could actually take loans out by issuing bonds that can be traded much in the same way as buying shares. What happens is that when markets become greedy and a bit complacent, they'll just buy any bonds. It’s not unlike a sale on the high street where people are buying up goods just because they are cheap and it’s the same with investing.

The next indicator, we talked about it before, is the VIX which measures spikiness in the market and there is another index that measures the volumes traded in safe haven assets.

So what they've done is look at each of them, give them a mark out of 100 which overall will indicate what emotion is driving the stock market. It's just a broad indicator that you can look at any time.

At present the Fear and Greed Index is about 46 but out of those seven indicators, two of them are flashing on fear. Two more of them are flashing on extreme fear. Another two are saying that it's actually on the greed side, and one of them is showing extreme greed. So if you take that all together it comes out that the market is being driven equally by fear and greed at the moment.

Fund Charge Ruse

This section is for those who have a financial adviser or have used one in the past, or going forward, might use one. The world of financial services is so archaic and the way it's worked has been so deceitful. It's just been one of those things that's always been done this way and people never questioned it.

So the thing I want to talk about today is the cost of advice, and particularly in relation to funds. Now, when you used to get advice a few years ago, before 2013, you'll get why 2013 was a key date later.

Let's just say you were going to buy an ISA or a pension that was invested in funds you would go to your friendly IFA and he would probably spin you a few lines and then give you a recommendation. He'd recommend a list of funds. So I'll use a company name just so we can reference it. Lets use Invesco Perpetual as an example because it's one that people may know. It's one of the biggest and it just helps with the story telling.

What would happen, is the financial adviser would recommend a whole list of funds, which some possibly being Invesco Perpetual funds. Now, the adviser used to say at that point that, "Oh, yeah, the cost of my fees are all wrapped up into this. I actually get paid at the back end." He didn't really disclose it that much, and he didn't legally have to. But as time went on and the rules changed and the adviser had to be a bit more explicit about these charges.

What would happen is each year, a certain percentage would be taken out of your portfolio by the fund manager. The fund manager would keep a big chunk of it, and then he'd give a portion to the IFA. So if we just use round numbers...

Let's say they take 1.5%, the fund manager at Invesco would deduct the money from their fund. They would then, around the back door, give the financial adviser 0.5% of the amount you have invested in their fund each year. Now that doesn't sound a lot, but when you actually work it out, over time, it has a huge impact on your portfolio.  So you're losing money every year. Don't forget, even years when your portfolio goes down, they're still going to take their 0.5%.

Fast-forward to 2013, a new set of rules came in after the Retail Distribution Review (RDR). RDR basically outlawed the old way of working in terms of taking backhanders in commission. So they had to charge upfront fees instead. They also had to approach their existing clients and say, "Do you know what? In a few years' time, the fund managers aren't going to be allowed to pay me this way. But because I'm so wonderful and I'll give you this great service, can you sign this letter? And we'll move you into this different version of the same fund, they call it a "clean version. What happens is that, the fund manager will only take 1% a year, rather than the 1.5% and give me 0.5% as they used to. We'll instead deduct 0.5% for me directly from your portfolio, is that okay?" And the client would hopefully say, "Yeah, you're so wonderful at what you do. No problem." They'll sign a form and then all the admin in the background would happen smoothly.

The investments would be the same, but they'd put you into different versions of the funds you were in, just because the charges are different. Very archaic. It's not as simple as being able to flick a switch, you have to be physically moved into new investments and that takes a bit of time.

That admin exercise is performed just so that the financial advisers could be in the same net position as before. I used to work in the industry and you can imagine the reaction of financial advisers when the new rules were announced. They were running around thinking the sky was falling in, cursing the regulator because they'd built up their businesses and then they're being destroyed overnight. But there was no point in kicking and screaming. They had to go and approach their customers and try and get them to give them fees another way as described

But of course, a lot of IFAs have lots of clients. They could have 800 or 900 clients. But they actually don't service most of them. So what they did was bury their heads in the sand as the rules said that if they didn't bother to say anything to a client, they could still keep taking old style commission until April 2016. So it became a case of "Let sleeping dogs lie." As long as the financial adviser didn't say anything, didn't alter their clients' investments, they could just keep creaming that money off the fund managers.

What happened from April 2016 is that they weren't allowed to do this anymore. That commission got turned off. So the financial advisers no longer get that 0.5% if they haven't done anything for it. But this is where the problem comes in. Because in the old style funds, where Invesco Perpetual, for example, were charging 1.5% and then giving the financial adviser part of that 1.5% (say 0.5%), they're no longer paying the financial adviser anything via the back door. Yet it doesn't mean that investors are keeping it, the fund managers are still taking the 1.5% because that's what the charging structure of that particular class of fund allows. The difference is that the fund house just keeps the lot!.

To stop this the fund house needs to move you to the new clean version of the fund you are invested in. But to do that, they have to get your permission. This is the problem, because the IFAs weren't contacting clients, the fund houses in the background don't have their contact details either. What this means is that there's about a quarter of a million people who are still paying for advice needlessly. Although the adviser is not getting the money, they're still paying the fee and the fund manager is keeping it.

These people could be doing this for the next 20 or 30 years and the fund house will keep an extra 0.5% of pure profit every year. So this is a wake-up call. To people out there if you've ever had financial advice, pre-2013, in particular, and your adviser never contacted you to say, "Look, the rules have changed can you sign this piece of paper so I can now get paid in a slightly different way, but the same amount? We're just going to shift you into this new version of the fund that's a bit cheaper." then the chances are, you're still being charged in the old way. You're basically, like I say, to use an analogy, driving around in a very inefficient car. You can get a free upgrade form the manufacturer, and it's much more cost-effective and cheaper to run.

So, what you need to do, if this could be you, contact the fund manager, not your financial adviser, because they probably just ditched you, to be honest, and they probably won't even take your call because they're not making any money out of you anymore since April 2016. Contact the likes of Invesco Perpetual or Fidelity, or whoever the fund manager is, and ask them what charges you're paying, and which version of the fund you're in. So when we talk about clean or bundled versions of a fund it means that the adviser's former charge is bundled into the fund's annual charge. The clean ones, like I say, will probably be charging you around 1%. And therefore, it's actually quite a bit cheaper. So you want to be in those clean funds, but do check before you do it that overall, your costs are going to be cheaper. Because some people might decide, "You know what? I don't need advice. I'm going to go and directly and run my money on my own." "Execution-only," they call that. So you go with a platform like Hargreaves because you don't want any advisers attached to your portfolio and siphoning money from it. Yet it can be that because all these other platforms have their own charges, in total, you could end up paying a bit more than you were before. So just double-check that.

The tip is, if you've ever had advice, contact your fund house and ask them what you're paying, and if that is the cheapest that you can pay.

Mortgage Calculators

If you want to take out a mortgage, particularly first-time buyers, you may go and check on a mortgage calculator to see how much you could borrow.

You would go onto their website and think, "How much could I borrow from..." let's say Nationwide or whatever and you would go on and complete the calculator, and it would throw up a particular figure, which would be, typically, some multiple of your salary. Where the issue comes in is that people don't realise that different lenders use different criteria, and even those criteria to arrive at the amount they're willing to lend can be different. So the maximum they will lend to you will be different depending on which calculator you use.

So you might go to Nationwide, you might go to First Direct, or whoever the lender might be, and use their calculators. You will find, if you go across the market, you will get a range of different answers. Now, that might not be news to some people but I think a lot of people might have thought it would be the same figure. Yet it's the scale of some of the differences that is quite alarming.

An article I read recently did a scenario where they got a case study and inputted it in a number of different calculators. The difference in the amount of the potential mortgage was a staggering £200,000 across these calculators. So you can see that for somebody who's a first time buyer, a £200,000 difference is significant.

The tip is that you should try a number of calculators not just one. The interesting point is why are they different? The reason is that each underwriting department use the criteria in different ways, and some of them don't ask the same questions. Some of them, for example, might ask about your credit card debts, while others won't be so bothered. So even if you're having to input different things, you can't really expect the answers to be the same. Some of them will use different multiples because they use different rules.

One word of warning, even if you do have a calculator and it goes, "Woo hoo, you can get four and a half times your salary," it doesn't mean you will actually get four and a half times your salary. At the end of the day, it's just a calculator. It's just a tool. It could be used a million times over, and it could keep telling a million people they're going to get four and a half times their salary. But if a million people applied for a mortgage, you can pretty sure they're not going to get that amount.

One of the biggest differences that they found concerned childcare costs. If you have a child, then the way they look at childcare costs varies and could massively reduce how much lenders would be prepared to lend. Yet some lenders aren't so bothered about childcare costs.

So the tip here is to shop around and use different calculators. Don't just base your research on what those mortgage calculators say, as they're not guaranteeing that you're going to get that size loan anyway. I suppose one of the biggest things to do is to seek independent mortgage advice. If you don't have a mortgage broker, you can find one here.

A mortgage broker can save you hassle and time as they will know who's going to lend you the most before you've even started applying, and your likelihood of actually getting it. They can look at your specific circumstances and say, "Based on what you've told me, these guys will probably mark you down a bit so we will try this lender instead."

On thing to bear in mind with these calculators is that the company will have in mind the type of people they want to attract. They've got a type of client they're trying to acquire because they know they can make more money by selling them other products over time. They will tweak the calculators to influence the flow of inquiries they get from the right type of person. What that means is the calculator isn't particularly genuine because it's actually being used as a marketing tool.

So just be careful of mortgage calculators, they're great tools and good general indicators. Great for a beginning bit of research to see what you can get and how much you need to save. Do realise, however that they are actually marketing tools for the companies, so you should take anything they produce with a big pinch of salt.

Don't forget to claim your free copy of Damien's bestselling book, "The 30-Day Money Plan: Sort Your Finances in Just 5 Minutes a Day," worth £4.99. Just go to moneytothemasses.com/podcast to find out how