I suspect you probably own shares in various companies in one way or another, be it through your superannuation, direct share investments, or managed funds. You may have exposure to Australian shares, not knowing that you can invest in overseas companies quite easily, companies like Google, Visa, Walmart, Netflix, FitBit, and thousands more well known names.
I also suspect that you don’t really have a strong view on any or most of stocks you own. Rather, you own them because you just want to be invested in the share market believing that over the long term, the share market offers a return greater than a bank deposit.
And that’s ok, because it’s true. Share market returns over the long term have historically been about 10% p.a, while deposit returns from the bank have generally been just below 5% p.a. Why the premium? Simple, volatility! If you put your money in the bank, you will generally get your 3 or 4% paid every year. With share market investing, you might get 17% one year, zero the next, -6% the next, and 22% the year after that.
However, if you need to pull your money out of the share market,say, to buy a house, and you need to do it at a time when there have been some downturns then you won’t get the super normal returns you’ve been told will come or even the 10% p.a return I mentioned above. And, as per Sod’s Law, it always happens that you need the cash right when markets look their worst – but hey, that’s just life!
So what should you do?
In order to counter this truth, many people are advised to invest in actively managed funds. The managers claim to outperform the benchmark index of their region which might be the All Ordinaries Index, S&P 500 or the FTSE 100 for example, through their superior stock selection, and prudent risk management techniques. Invariably they will invest in roughly 30-50 stocks,instead of all the stocks that make up the index, tell you that they will avoid buying the ‘dud’ stocks (like resources), which is why you should give them your money to manage.
On the face of it, sounds pretty sensible, right? These guys manage money all day, have access to information and people that the man in the street doesn’t, and have apparently done it for a long time. For all of these reasons, they charge a fee, which again sounds fair enough. But get this: the fee that these guys charge to give you a ‘better’ return than the index, is anywhere from 5 to 20 times the fee to invest in the index itself.
This begs a very simple question
Do I give my money to an active manager and hope he can beat the index (plus their fee) , or do I just buy the index itself and pay almost no fee?
My answer is no. A definitive no at that, and here’s why.
Most of them don’t even beat the index! It’s that simple.
According to the 2015 mid-year scorecard from S&P Dow Jones Indices, 52% of Australian Equity General funds were beaten by the index over 1 year; 55% over 3 years; and 71% over 5 years.
Read that again.
Between 50-70% of the managers to whom you pay a fee of between 5 and 20 times the amount you need to pay to achieve the index return, have delivered a lower return than the index! International managers have fared even worse, especially over 5 years – 90% of them have failed to beat the index they compare themselves to.
Of course there are money managers out there who have, and will continue to beat the index. Finding them is hard enough. Knowing which of them will continue to provide superior returns is near impossible, as almost no one has ever done it for a protracted period of time. The greatest investor of all time, Warren Buffett, has earned investors roughly 20% p.a for about 50 years. What a legend! But here’s the thing: Mr Buffett is now 83 years old and sadly, won’t be around for ever. What’s he going to do with his money once he’s gone? (After giving a big chunk to charity of course…)
My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s). I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers
The Man has spoken.
And so have I.