Place your bets wisely!Rujuta Tamhankar
The vast majority of people have no edge over others in the stock market. Even professional fund managers who have demonstrated skill in picking stocks in the past struggle to beat the market once their high costs are taken into account.
The way of the Rational Investor– Keeping costs low is vital to being a Rational Investor. Since you are not going to outperform the market, it makes no sense to pay a penny more than you have to in order to achieve as close to the market’s return as you can. By keeping costs low, you can end up richer than those who pay a high price to try to beat the market and fail.
Active management comes at a cost– Fees are always important in finance, but even more so for the Rational Investor. Paying initial fees just to get into an active fund is becoming a thing of the past, but you might still save another 2% a year by investing in an index tracking fund, compared to an active one. If a 2% annual saving does not seem like a lot to you, then you’re forgetting the power of compounding returns. If you think you have great edge in the market and you could easily make up this 1.5% to 2% annual cost difference by picking stocks or choosing superior active fund managers or timing the markets or whatever other approach you take, then good luck to you. All the odds and evidence are against you. If you don’t have an edge, then the sooner you get out of the expensive investment approaches and into cheap index tracking products, the better off you will be.
How to get an active manager’s sports car– Conversely, consider the 85-90% of investors who invest in active managers as opposed to index tracking funds, either directly or via their pension funds. Over the long run only a very small percentage of investors who take the active approach will be lucky enough to invest with managers that give better returns after fees. The rest have simply paid a staggering amount of money to the financial industry over their investment lives, and will have less money in retirement as a result.
Passive investing requires patience– The key to reaping the greatest savings is to have the patience for the compounding impact of the lower expenses to take effect. It is like making money while you sleep; lower fees make a little bit of money, all the time.In the early years you can barely see the difference between the active and index tracking investment approaches. In the later years the benefits are obvious – but they are only there for the investor who kept his or her discipline with lower fees.
Ignore the siren songs of sexy managers– you must remember it will take discipline to stick to this approach. The index tracker will perform slightly better over the long-term than the average active fund, and that outperformance will come from the cumulative advantage of lower fees. Meanwhile the many active funds out there will be all over the map, the best performers will try to scream the loudest about how their special angle or edge has ensured their amazing returns that year. We might even be tempted to believe these managers and abandon our boring and average index tracking strategy. But please stick to your index investing plans unless you can clearly explain to yourself why you have edge. The chances are you don’t, and you will be wealthier in the long run from acknowledging this.
Source: The cost of active fund management published on Monevator
Asset Multiplier comments:
- The most underutilised investment skill is patience, but it can be developed.
- Fund outperformance is unpredictable, and forecasting a successful mutual fund may be difficult. An additional savings of 2% (of management fees) put in a low-cost passive route may be a better decision for an investor.
- The gap between price and value, often known as the margin of safety, protects an investor from unanticipated occurrences and allows him or her to obtain extra profits in the absence of such events.
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