DIY InvestorMagazine
/
March2014
DIY InvestorMagazine
/
March2014
14
15
5
COST – BEWARETHECOST
MONSTERS
One of the biggest risks that long term investors
face is cost – and yet too few see cost as a risk at all.
“In every time period and every data point tested, low
cost funds beat high costs” “Expense ratios are strong
predictors of performance. In every asset class over
every time period, the cheapest quintile (cheapest fifth)
produced higher total returns than themost expensive
quintile (most expensive fifth)”
INTHE LONGRUNRETURNS
Real assets (e.g. equities / property) have historically
outperformed cash and bonds over the long run. A key
point is that asset allocation, howmuch you invest in
bonds vs. equities for example, has been shown to be by
far the biggest driver of long term returns and is far more
important than which equity you are invested in.
Using index funds to get access to a range of asset
classes is a sound strategy. Perhaps adding some
specialist active satellites to spice up returns in smaller
areas (small companies, commodities.)
Academic research into the performance track records
of active funds bolsters the case for passive investing.
An analysis of past performance figures concludes that,
although some active investors possess skill (or luck), the
average fund typically under performs themarket.
Even themost skilful investors struggle to produce
consistent out performance. And the time, effort and
therefore cost that would be required to select these
managers (in advance if any hoped for out performance)
is probably greater than the extra return anyway!
INVESTING ISNOTANART -
IT ISA SCIENCE
Investing needs a clear long term objective based on
understanding the risk and returns you are seeking. Then
you need to use the key rules of investing to help you
achieve your goals:
•
Get the right mix of assets tomeet your needs
•
Diversify
•
Rebalance (keep your asset mix on track by
checking it as the environment changes)
•
Keep costs low
•
Save tax where you can – using your ISA allowance
will build up a tax exempt pot for the future
Index or passive funds are an excellent low cost way to
achieve very broad diversification within an asset class
at low cost. Combining index funds into a portfolio
tailored tomeet your needs – by using perhaps 10 or
so index funds or simple ETFs – is a great way to invest
for the long term. And stands more chance of making
you, rather than the fundmanager rich!
My investments? All invested in a diverse portfolio of
index funds and ETFs…mymoney is wheremy
mouth is!
David Norman
CEO
TCF Investment
EVERY POUND THAT IS TAKEN FROMYOUR INVESTMENT INCOSTSORCHARGES
IS LOST FOREVER. AND SO IS THE RETURNON THAT POUND…EACHAND EVERY
YEAR IN FUTURE
Unfortunately the investment industry isn’t always as
good at showing the full costs as it might be. Always
look for the Total Expense Ratio (TER) or Ongoing
Charges Figure (OCF) of a fund, rather than just the
Annual Management Charge (AMC).
Also check out the Portfolio Turnover Rate (PTR) to see
how often themanager is trading the stocks and shares
inside a fund - and thus howmuch extra cost drag the
manager is generating from the trading.
Another good reason for choosing index funds is that
they trade far less often – so have lower running costs
as well as lower expenses.
Morningstar in the US conducted some analysis in 2010
to identify the best historic predictors of performance.
The results are remarkably clear:
Choosing low cost index funds gives you a head start
when building your portfolio. And the same goes for the
cost of any wrappers (ISA or pension) that you select.
Make sure you know the initial costs, the running costs,
the switch or trading cost and any other charges.
If you are choosing active funds make sure themanager
has the right benchmark for your needs (comparing
their performance to an index rather than the sector for
example).
And if you can try to assess the risk adjusted return – any
manager can takemore risk but do you get extra return
for the risk taken?
