Is investing in Managed Funds the stupidest thing you can do with your money?

I've been a fan of podcasts for quite some years now. There is a huge choice to listen to out there. One of my favourites is Freakonomics. You may have heard of Stephen Dubner's best selling book entitled “Freakonomics”. Stephen, in his podcasts, takes an entertaining look at every day things from an economics perspective (I know you’re yawning already but give the show a go) and explores the “hidden side of everything” in an informative and entertaining way.

In his most recent show “The stupidest thing you can do with your money” Stephen considers the cost/benefit of using Funds managers Vs Indexes for longer term investing and the revelations are startling.

In this podcast, Stephen interviews of a range of people including Kenneth French (“Roth Family distinguished professor of finance” Tuck school of business in Dartmouth in the US) and Nobel Laureate, Eugene Fama about the added value funds managers bring to investment performance in the longer term.

Remembering this is a US based show, they note no more than 2% of funds managers consistently outperform the market to the extent that their returns consistently cover their costs and match or beat the markets in terms of performance.

The “Harsh truth about managed funds” was an article from the Sydney Morning Herald dated 27/05/2013. In this article, Clancy Yates considers historical performance of funds compared the indexes in which they are investing. Although this article is now 4 years old, similar results are proving to be the case now. Clancy notes (of the Mercer comparisons of large funds performance over a 3 year period to March 2013) the top performers did outperform the market by 0.2% (Typical return of 7.4% compared to the market returning 7.2%) but when costs are taken into account (typically ranging between 1% and 2.5%) any advantage has been wiped out. We haven't considered the cost impact of advice on these results either.

Stephen Dubner asks the question why would you pay for advice when these are the outcomes? He notes how complicated investing can be;

  • The terminology is difficult
  • The options overwhelming
  • The cost structures are complex and multi layered

Certainly, there is a role for a professional planner to provide advice and guidance around appropriate structuring and investment selection. But he goes on to wonder why individuals continue to pay significant fees for what is at best a disappointing result.

Kenneth French notes investors suffer from over confidence. Particularly in a noisy environment (Advertising to encourage people to invest with one group over another) where feedback is weak. The stock market is a perfect example of a particularly noisy environment.

At the heart of this podcast is an interview with Jack (John) Bogle, founder of Vanguard Index Investments. Whilst the company started in 1974, he was the first person to establish an index fund by replicating the US S&P500.

His concept was simple. “Bogle’s idea was that instead of beating the index and charging high costs, the index fund would mimic the index performance over the long run -- thus achieving higher returns with lower costs than the costs associated with actively managed funds”. At the core of his investment philosophy was the distinction between “investment” and “speculation”.

Investment and speculation lies in the time horizon

The main difference between investment and speculation lies in the time horizon. Investment is concerned with capturing returns on the long-run with lower risk, while speculation is concerned with achieving returns over a short period of time. Bogle believes this is an important analysis to be taken into account as short-term, risky investments have been flooding the financial markets.[1]

Bogle argues for an approach to investing defined by simplicity and common sense. Below are his eight basic rules for investors:[2]

Select low-cost funds

Consider carefully the added costs of advice

Do not overrate past fund performance

Use past performance to determine consistency and risk

Beware of stars (as in, star mutual fund managers)

Beware of asset size

Don't own too many funds

Buy your fund portfolio - and hold it

Jack Bogle also notes an investor revolution is taking place. In the US, more than half a trillion dollars has exited Managed Funds and 1.5 trillion has gone into index funds. This is not in the least bit surprising given the high cost of actively managed funds out there both locally and in the US.

Recognising that occasionally a funds manager will have an outstanding year is completely acceptable. Whether luck or good stock picking played a part in this outperformance is a trickier matter to address. The more important question goes to the sustainability of outperformance. Review a fund that has had an outstanding year and consider their performance over a 5 year period.  When compared with the benchmark in which are investing in, how did they perform after fees over a longer period?

LifeTime Financial Group’s Investment philosophy

This approach goes to the heart of LifeTime Financial Group’s investment philosophy.

Jack Bogles’ approach goes to the heart of LifeTime Financial Group’s investment philosophy.

We recognise the need for Investors to receive “factual” and “ clients best interest” based advice.

Using a similar set of rules to Jack Bogle, LifeTime Financial Group are only interested in longer-term returns with lower volatility (Accepting markets do go up and down) and lower overall costs.

LifeTime Financial Group specialises in managing wealth for busy Australians using a pragmatic approach to managing the overall portfolio. Our services include Advice in relation to investing, guidance on appropriate structures to hold those investments and ongoing management and review of the funds we manage for our clients. Both inside Superannuation and also personally invested wealth.

Our approach to the investment process means total costs of provision of all services are typically around 1.1% (GST inc) of total funds managed. This fee includes

  • Ongoing investment Advice
  • Rebalancing of portfolios
  • Investing additional contributions
  • All formal review advice documentation on an ongoing basis (There is an upfront cost for initial advice and Implementation)
  • Management of your investments including
  • monthly reporting,
  • provision of all required information to prepare your compliance obligations including tax returns and audits etc.

When you consider funds typically charge between 1%-2.5% for administrative functions and advice costs charged over and above this, the LifeTime Financial Group offering is both competitive and compelling. Don’t forget our fees are also deductible to the entity that owns the funds thereby reducing them even further.

And we don’t take any form of commission on investing clients funds.

LifeTime Financial Group is a boutique financial advisory firm whose specialist advisors (holding appropriate accreditations) are ideally positioned to assist you with a wide range of investment advice and guidance needs.

Would you like to discuss your personal position further with one of our highly qualified financial planners? Why not call us today on 03 9596-7733. There is no cost or obligation for our initial conversation/meeting.

Written by Anthony Stedman of LifeTime Financial Group. LifeTime Financial Group is an award winning and privately owned Melbourne based Financial Planning practice specialising in managing the financial affairs of busy wealthier Australians.

Source information:

Freakonomics podcast

[1]  Bogle, John (2012). The Clash of Cultures: Investment vs. Speculation. John Wiley and Sons, Inc.

[2]  Sigma Investing. Review of Common Sense on Mutual Funds.

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