With markets this volatile, you need all the help you can get to make your money perform. But what’s the best way to do this? Should you pay for an expensive fund manager with a decent track record in the hope of getting superior returns? Or should you keep costs to a minimum and stick with cheaper products?
Some fund managers pooh-pooh the idea that you can make a decent return without their help. They’ll tell you that, in order to get top-notch performance, you need to pay for it. But a recent study concludes that such an argument is becoming pretty difficult to sustain.
Start-up fund-management firm TCF has examined the returns of the three main fund categories recognised by the Investment Management Association (IMA, the industry’s trade body): ‘active’, ‘balanced managed’ and ‘cautious’.
Its approach is novel, tracking performance according to the total expense ratio (TER). This annual charge factors in everything from management expenses to trading costs. TCF has looked at how both the cheapest 25% and also the most expensive 25% of funds by TER fared compared with the average performance of all the IMA-monitored funds in each category over three and five years. Their conclusion is stark.
In the ‘active’ sector, the lowest-cost funds returned over 1% per year more than the most pricey. It was a similar story among ‘balanced managed’ funds. And over five years in the ‘cautious’ sector, the cheapest funds returned an average of 2.9% a year and the most expensive returned 2.31%.
These may not seem like big differences, but they really mount up. For example, say you invest a straight £10,000 for 25 years. If over that time you can improve your return to 6.5% per annum from 5.5%, at the end of that period the extra amount you’ll receive will actually be more than your £10,000 starting capital. “Our analysis shows that costs are a very strong predictor of future returns,” says TCF co-founder David Norman. “Yet the industry – which is getting away with rising charges and trading costs that appear out of control – does its best to hide this from the investor.”
So what should you do about it? It’s over to Norman again. “Every pound of investment cost is a pound lost – forever. Advisers and planners should ensure that expense ratios are one of the top factors used when selecting funds.” In other words, before you buy any fund, check the TER – if it’s high, pick a cheaper fund.
Category: Economics