The Coffee Lounge

  • Lesley James

It can pay to keep things simple

There are easier ways to get your money moving than risking everything on what might be the next 'big' idea...

There is a debate going on in financial services at the moment that has pitted two groups of investors with deeply entrenched views right up against each other. It is a debate that even Warren Buffet, the world renowned CEO of Berkshire Hathaway, has got himself into.

No, not Brexit (*phew!*). This one is the 'passive versus active' debate. A debate that, thanks to some rules introduced back in Jan 18, has finally made it's way into the mainstream.

But first, what IS passive and way all the fuss..?

Passive (tracker) funds

A passive fund is so called because it doesn’t make any decisions about where to invest. It just invests. In everything. Whatever companies are listed on the market the fund is targeting, that fund will buy. In the same proportions as the index it is tracking.

No relative merits are considered, no predictions are made. It just invests.

For example, let's take a passive UK fund, tracking the UK FTSE All Share index. With various tools and computer models that fund will take a position in every single All Share listed company. Both Sainsburys and Tescos, both Unilever and Proctor & Gamble, both BT and Vodafone. In proportions precisely equal to the index weightings of each of those 6 different companies.

The result? As the market and its companies go up in value, so does the fund. As the market and its companies fall in value, so does the fund. And the performance you experience as an investor will be exactly that of the index.

Minus an amount for the fund charges. But, with passive funds, the fees are very low. And therefore have (relatively) very little impact on the return you can expect on your money.

Already you can invest in funds tracking the UK stock market for less than 0.1%. And Fidelity has just launched the first zero fee tracker ETF. Price competition is fierce.

Active (stock-picking) funds

An active fund, in contrast, is built on the idea that, with skill and appropriate foresight, it is possible to 'outperform' an index. And, if you are really good at what you do, manage that with fewer ups and downs (ie: lower volatility) than the index itself might experience.
Making not only the outcome better for investors, but causing fewer worries along the way.
Rather than simply buy, then, an 'active' manager will make active decisions. He/she will buy only companies they believe have potential. And will avoid companies they believe do not.
All this work, however, costs money. The manager's wages, the research - and the costs involved in actually dealing. Typically, the total fees you pay for one of these active funds will range from perhaps 0.75% to over 2% a year (and may be higher in the niche markets).
Which is the main rub. For an active fund to beat a passive fund, they need to achieve a return that is not only higher than the index, but is higher than the index plus the additional fee. Otherwise the investor is no better off than the cheaper fund.

And, for an active fund to beat a passive, the return not only needs to be higher than the market plus its fee once. That needs happen consistently. This year, next year and every single year after that. In all market conditions.
Regardless of how well someone has done in the past, how many winners they have picked before, there is always the chance that they will make the wrong choice. And the reality is that under-performance is much more common than most people think.

Which means, not only have thousands of investors missed out on higher returns, they have paid more for the privilege.
Enter: The Financial Conduct Authority
The debate about passive versus active became particularly fierce towards the end of 2016. A study by the UK regulator, the Financial Conduct Authority (FCA), found that £109 billion of investors money was in active funds that did little more than passively track the index. Sometimes, at least to an extent, intentionally.
Called 'pseudo-trackers', these funds have virtually zero chance of outperforming an index. Partly because they are making too few active decisions to make a different and partly because the fees charged are up to 10 times those of the equivalent passive fund.
What's more, many investors in those funds are probably unaware of the issue. That same study suggested that over half investors don't realise they are even paying a management fee, never mind that they could get exactly the same thing - better - for a fraction of the price elsewhere.
This has significantly raised the stakes.
Active management is now under scrutiny as never before. Warren Buffet – renowned as one of the best stock-pickers of all - has suggested that normal investors should just target index funds. And on 12 Feb 18, The Telegraph ran the headline “Revealed: how wealth managers' fees can halve your total returns.

Our opinion

As a business which does not make personal recommendations, we can’t say precisely what is the right answer for you. However, our 25+ years of experience has taught us three important lessons:
  • How much and how consistently you invest will have a much greater impact on your future than what companies you choose.

  • Tracking markets gives you a pretty good return, without the need to try and squeeze the odd extra % or so from them.

  • Fees are the one thing over which you have total control. You therefore need to know how much - and what you are getting for it.

There is nothing wrong with investing money with a good active fund. It could, potentially, help to make you more money. If you can find one with appropriate risks and objectives, run by a skilled manager. Or you can dip in at the right moment and get out before the wrong one. There are a few managers who have demonstrated that some level of skill lies behind their out-performance, and it has not all simply been down to luck.

But not very many.

At Simplified Money, therefore, we advocate that everyone starting out on their investment journey starts with a low cost, globally invested, passive fund. They are low cost, easily accessed, offer great diversity, cater for all risk profiles - and carry out the re-balancing as well. Which minimises the need for monitoring, to keep all those risk levels in line.

And our 'top rated funds' list reflects this belief.

Plus, when you have a decent, low cost, diverse base for your portfolio, it can give you much more scope to go 'off-piste' later, should the feeling take you.

Please note: The value of investments can fall as well as rise, and you may not get back all of your original investment.

#Investment #Financialplanning

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