All You Need To Know About Passive Investing
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The increased popularity of index-tracker funds has put the cost of actively managed funds under greater scrutiny, particularly if you pay an adviser as well.
Is Your Active Fund An Expensive ‘Closet’ Index-Tracker Fund?
The Cost Of Index-Tracker Funds Is Falling Dramatically
The cost of passive index-tracker funds, which track an index like the FTSE 100, rather than an active fund where the manager picks stocks they believe will perform well, is falling.
Index-tracker funds that follow UK and US markets can be bought with charges as low as 0.07%. Active funds typically cost around 0.75%. The additional charge covers the cost of an experienced fund manager who’s expected to beat the market.
If your fund manager sticks too closely to an index, you really should question what you’re paying for.
Watch This Index-Tracker Video
First published by Citywire in April 2013, when the cost of index-tracker funds were a little more expensive, this is a helpful video on the ‘active versus passive’ debate.
Index-Tracker Funds Report Record Inflows
According to the Investment Management Association, index-tracker funds saw record inflows in October 2014, having attracted net retail sales of £590 million. This takes the index-tracker total to £89.3 billion.
Daniel Godfrey, the chief executive of the Investment Management Association said: “In October, equity was once again the best-selling asset class by far, with UK equity funds attracting the most retail sales and UK Equity Income continuing to be the best-selling IMA sector for the fifth consecutive month.”
Legal & General has just slashed the cost of 16 index-tracker funds. Its head of retail distribution, Honor Solomon said: “Index-tracker funds make up 10 per cent of British funds under management. Price is a key factor in the popularity of index-tracker funds and we are delighted to be able to bring to market a highly competitive set of new prices on a comprehensive range of asset classes.”
Is Your Adviser Delivering Value Compared To Index-Tracker Funds?
If you invest in low cost index-tracker funds, you’ll pretty much earn average growth on your money in each of the sectors of the market you’re tracking.
If you pay an adviser to choose funds for you, it follows that your growth rate has to be better than average to cover the cost of their fees, and the fund managers' charges. Whilst your adviser may deliver above average performance in some years, they’re bound to have some below average years. No matter how good they are, it’s most unlikely your adviser will be able to beat the market all of the time, as it’s impossible to know what stockmarket performance will be next week, next month or next year. Here’s the point.
Statistically, the longer you hold your money, the likelihood is that your actual performance will tend to be nearer the average performance of the sectors in which you’re invested. So when you take into account your adviser’s charges and the fund management fees, unless your adviser is consistently delivering above average performance, there’s a good chance you’ll be down on the deal compared to index-tracker funds.
If your adviser is charging you to pick index-tracker funds, or closet index-tracker funds, you’re almost certain to see net performance at a below average level. That could cost you dearly.
The average annual fee charged by independent financial advisers that make funds selections, usually for a range of risk scored portfolios, is 1 per cent each year. However, some advisers charge 0.5 per cent each year, choosing to contract out the fund selection choices to a discretionary fund manager, who may typically charge around 1 per cent each year.
It follows that your funds need to consistently perform between 1.75 per cent and 2.25 per cent better than average. That's not just in one year. That's in every year, in order for you to see a higher net growth rate compared to passive index-tracker funds.
The average SIPPclub member has around £250,000 in their SIPP. If you meet your adviser twice a year to re-evaluate risk, followed by them performing the relevant financial planning functions, it equates to £1,250 per meeting. If the adviser uses a discretionary fund manager to make the investment selections, your cost per meeting rises to roughly £1,900 per meeting.
No matter how strong your relationship with your adviser, you have to question whether this represents value for money.
The good news is that it’s relatively easy to check you’re getting value for money with a pension review. It’s something you should ask your adviser to carry out for you, as part of your fee.
Warren Buffett’s View Of Index-Tracker Funds
So, if the longer term growth your adviser is delivering you, net of their charges, any discretionary fund manager’s charges, and the active fund management charges is greater than the equivalent index-tracker funds, you have nothing to be concerned about.
But if you’re losing out, you really should challenge your adviser. Where appropriate, you could consider switching your money to index-tracker funds. After all, your financial future depends on it!
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