A fool and his money

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The Independent Online
Starting today: a 10-part series based on the Motley Fool UK Investment Guide. Tom and David Gardner set up the Motley Fool website in the US to show ordinary people how to manage their savings more effectively - and beat Wall Street experts. Their name comes from the multi-coloured jesters who lived at the early English courts; the only ones who dared tell the king when he was wrong.

The US Motley Fool is a massive business, which has spawned several best- sellers. The first British Motley Fool book, by David Berger, offers the same philosophy of plain-English (and funny) help for the UK investor. During this exclusive series we'll bring you the best tips in the book and show you how to start making more of your money.

Week one: why you need to invest

What investing means

Investment is something we do every day, consciously and unconsciously. We invest in our relationships, our jobs, our hobbies and our lives. If we didn't invest in these things we wouldn't get anything back, or at least nothing of very much worth. And investment is all about "getting back". We invest something, whatever that may be, in the hope of a return over and above the original input.

It seems so pathetically simple that you are probably wondering why we are going on about it. What is interesting, however, is that while we put a lot of effort and time into, say, investing in our relationship with our partner - flowers, surprise weekends away - so often we put pitifully little thought or effort into investing for something as vital as our financial future.

There are quite a few reasons for this and we will go into them later in the series. The purpose of the Motley Fool is not to turn you into an investment geek - an anorak who is barely able to converse with fellow human beings except in terms of earnings per share and cash-flow analysis.

Instead, we hope to awaken more than a spark of excitement in the thrilling and very Foolish business of investing.

The business of managing your own money and guiding your financial ship towards its ultimate destination is as fulfilling as it can be simple and as enjoyable as it can be lucrative.

A little bit of history - or why we all need to invest

Time was when you could expect to work all your life, retire at 65, and drop dead shortly after. The advantage of this system was that it meant there was no need for investment by the state to provide a wage for the country's pensioners. The number of people in work so far exceeded the number of OAPs that incoming taxes were more than able to cover the outgoings.

Now though, not only are people living longer, they are retiring earlier and earlier. Whereas there were about five employees per pensioner in the 1950s, there are likely to be closer to two per pensioner in the second decade of the next century.

Up until 1981 the old-age pension was linked to average earnings. This meant that as average earnings went up each year, so the pension increased by the same percentage amount - an arrangement which seems equitable enough.

The only problem was that this was costing more money than the government could afford. The solution? Instead of linking the pension to average earnings, link it to the retail price index (RPI - the rate of inflation to the rest of us).

This sounded all right in principle, but the fact is that the RPI appreciates on average by around 2 per cent less per year than average earnings. In effect, this means the state old-age pension is now depreciating at 2 per cent per year in relation to average earnings.

By the next century the old-age pension will stand at somewhere between 10 and 20 per cent of average earnings, or so the National Association of Pension Funds predicts.

Something had to be done about the future destitution of the nation's pensioners and, you will not be surprised to hear, the onus was put on individuals to save for themselves.

This took the form of savings incentives like the personal equity plan (PEP), introduced in the mid-1980s, and the personal pension plan, introduced shortly after.

They are both tax-efficient savings which have had quite a degree of success. This success, however, has only really been among those who could afford to pay - and that includes paying for the charges they carry. A report by the Association of British Insurers reveals that even people who pay personal pension contributions for 30 years can see a quarter of their final investment fund eaten up by charges.

This is loadsamoney and someone, somewhere, is laughing all the way to the proverbial bank. Just how hard they are laughing will be revealed later in the series.

It is fair to say - whatever pups the financial services industry has sold us to date - that governments now and in the future will have to continue to encourage personal saving in a big way, because pictures of pensioners in soup queues don't do much for the image of "Cool Britannia".

All this, of course, is splendid news for investors.

What is a Foolish Investor?

Most people who have a pension plan or investment plan of one sort or another do not think of themselves as "investors". They just think of themselves as someone who has a pension plan or investment plan. If you start to consider yourself as an investor, rather than just simply someone who pays into a pension plan, this changes the mindset, broadens the outlook and, crucially, it puts a level of responsibility on you to ensure you look after your investments. "Looking after your investments" means ensuring maximum return with minimum cost in terms of charges and tax.

By calling yourself an investor, whichever investment vehicle you choose is simply that - a vehicle. In the other case, by contrast, investments are potentially fragmented into a pension plan, PEP and a host of other things - each in its own encapsulated world.

The investor, or rather the Foolish Investor, is able to take an overview and to think in terms of Total Return. As long as an investment is pulling its weight in the Total Return scheme of things then that's fine. If it isn't then Out It Goes.

Total Return is (almost) all that matters. By Total Return we talk here of the return, after all taxes and charges, on the sum of an individual's investments. Very little else is relevant.

Whether an investment is sold as a School Fees Plan or a Put Your Dog Through Obedience Training Plan or a Personal Pension Plan is irrelevant. Does it bring in the rate of return you expect, at a cost you are prepared to bear? It is very simple but it involves being prepared to sweep through the suffocating layers of humbug which envelop much of what the financial services industry is busy peddling to the British public.

If you concentrate on Total Return you will soon be able to distinguish when you are contributing more effectively to the Send a Fund Manager to the Bahamas Plan than to the Retire at a Young Age Plan. Sadly, many more people are contributing to the first plan than to the second.

Think of yourself as an investor. You have thoughts and opinions about all kinds of things and you can have them about investing too. Once you have got to the end of this series and visited the Motley Fool internet site, you will have the basic knowledge necessary to cut away the confusion and hype of so many of the investment products being marketed in Britain today.

Next week: the miracle of compound interest and how to sort out your existing investments.

Extracted from the Motley Fool Investment Guide by David Berger with David and Tom Gardner, published by Boxtree at pounds 12.99. David Berger, David and Tom Gardner, 1998. To order a copy with free delivery, call 0181-324 5522.

You can visit the Motley Fool website at www.fool.co.uk

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