Passive beats active for the money of mere mortals
Passive beats active for the money of mere mortals
Active investors hope to pick winners among the many stocks, fund managers and investment styles available, all while trying to buy low and sell high. These investors forget that markets are often moved by news that is unpredictable and random.
With markets remaining volatile, David Gow, a financial planner at Acumen Financial Planning in Edinburgh, presents his top ten guide to being a passive investor.
1. Wise words
The odds of finding a fund manager who will consistently beat the market are stacked against investors. Even Warren Buffett, the world’s most famous investor, admits that a “very low-cost index fund is going to beat a majority of the amateur managed or professionally managed money”. Active investing is, therefore, neither a viable nor profitable strategy for the general public.
2. Nobel nous Since 1901
The Nobel Prize has been awarded to men and women from all corners of the globe for outstanding achievements. Many academics have earned Nobel Prizes for their research and explanation of how stock markets work. More than 100 years of academic research points to index funds as an investor’s best bet.
3. You can’t count on luck
The primary factor determining the success of a stock picker is luck. Numerous studies have shown that only about 5 per cent of stock pickers consistently beat their benchmark.
4. Timing the market is impossible
It’s notoriously difficult to time the market correctly, largely due to the high concentration of returns that occur each year in just a few days. In a recent ten-year period, 100 per cent of total stock market gains happened in just 20 days.
5. You’re fired!
Active managers have a high turnover rate, so you could buy into a fund only to find the manager isn’t around for long. It’s almost impossible to
follow “good” managers: a recent study of 660 manager changes revealed that, on average, fired managers beat hired managers in the three years following their hiring or firing.
6. Cut the costs
If you invest in actively managed funds, you’re unlikely to know just how much of your money is being soaked up by fees. Unit trust and Oeics typically have initial fees of 5 per cent of your investment, to cover marketing and distribution costs, including commission paid to financial advisers, usually about 3 per cent. Then there is the annual management charge (AMC),
normally about 1.5 to 1.75 per cent. The best measure of cost is the total expense ratio (TER). Funds of funds, for example, might quote an AMC of 1.5 per cent, but after the underlying fund costs are taken into account the average TER is 2.21 per cent. On top of this, a growing number of fund groups are charging extra so-called “performance” fees. There can be exit charges too.
7. Eliminate fees
Costs associated with buying and selling shares within a fund’s portfolio are generally not included in the TER. Alan Miller, a former fund manager at New Star, recently estimated that these costs would add a further 1 per cent a year to the average TER on a unit trust or Oeic in the UK All Companies sector, based on the average portfolio turnover rate of 57 per cent. Turnover on index trackers is low, if not zero – eradicating this additional drag on performance.
8. Recording details
Last year, Vanguard Investments UK launched a range of low-cost index-tracking funds that do not pay trail commission to advisers. By removing this commission, the TERs on Vanguard’s funds are well below average. They range from 0.15 per cent for its FTSE UK Equity index and UK government bond index tracker funds to 0.55 per cent for its emerging markets stock index tracker.
9. Look to small caps
Dimensional Fund Advisors (DFA) takes Vanguard’s business model of providing low-cost index funds a step further by offering index funds in a variety of asset classes not available anywhere else, such as domestic micro-cap and emerging market small value stocks. DFA claims that, over time, small-cap stocks will outperform large-caps.
10. Exchange-traded funds
Exchange-traded funds are becoming increasingly popular and, like traditional trackers, are very cost-effective. They are securities that closely resemble index funds, but can be bought and sold during the day just like common stocks. These vehicles give investors a convenient way to buy a broad basket of securities in a single transaction. You can track anything from a well-known stock market index to the price of gold,
By David Gow
Published in The Scotsman on
