Low cost wins the race

You’re investing in shares for the longer-term, and would rather do this using a fund over selecting individual companies to invest in. There’s one more choice to consider – whether to invest in an active or passive fund.

What is an active fund?

What is a tracker (or passive) fund?

What is an index?

What’s better – surely active managers do better than a tracker fund?

You’d think that a team that spends their working day researching companies would be great at picking the winners and losers. Surprisingly, the opposite is the case. As the chart below shows, the majority of active funds do worse than the index they’re trying to beat. Here’s a chart that explores the failure of active fund management to outperform the index or benchmark. It shows the percentage of active funds that did worse than the benchmark (i.e. US Large Cap or Emerging Markets index).

So why is this?

Two reasons. First, that fund manager and team of analysts we mentioned are very highly paid, and these costs are ultimately covered by you – the investors of the fund – and over time these costs eat away at your performance.  Second, picking winners is really tough. Predicting the future is hard, and it’s easy to get wrong-footed by the daily market gyrations…

Costs can eat away at your returns so reduce them where you can

Here’s a hypothetical example of what you’d lose if you were to pay 2% in fees for your fund over a 25 year period, versus no fees (which is never the case but useful as a comparison). This includes direct expenses and also the amount you lose because the money you pay in fees isn’t invested.

 

Quiz: To draw attention to the benefits of simple tracker funds Warren Buffett, often considered the world’s most successful investor, bet that a tracker fund (that tracked the S&P 500) would outperform a basket of five complex hedge funds over a 10 year period.

What happened?

  1. He won! During the course of the bet, the S&P 500 tracker fund made gains of 7.1% per year compared to Portege Partners’ 2.2% per year.
  2. He lost! The actively managed hedge fund beat the tracker fund
  3. There was no real difference between the two

 

 

 

Quiz answer: 1

All investing should be regarded as longer term. The value of your investments can go up and down, and you may get back less than you invest. Past performance is not a reliable guide of future performance.