Make Your Investments Go Further with Passive over Active Management

As much trouble as the “financial innovation” of the prior decade caused with the global financial collapse, financial innovations did actually bring some great new investment options that actually are very beneficial to investors.  One of the main investment tools that is gaining ground in the UK is the availability of exchange-traded funds (ETFs) that track an index passively, rather than the common actively managed funds that people have been used to for years.  Here are several key advantages to investing with passive index ETFs over actively managed investments:

 

  • Most Investment Managers Can’t Beat the Index – This is one of the most incredible, yet true parts of the investment world that never ceases to amaze me. Between the UK, the rest of Europe and America, there are literally thousands and thousands of professionally managed funds and accounts that have high fees that do not beat the returns by the basic index they’re trying to track. Depending on the study you look at, which country, and which index you’re comparing to, the results vary, but the outcome is always the same.
  • Paying for Poor Performance – The vast majority of professional (and highly paid) investment professionals do no better than if you did nothing at all other than invest in the various stocks or bonds in a particular index. So, why bother paying the higher fees at all? If you could pay a 1.5 percent annual fee for sub-par performance or a 0.5 percent fee for “average,” why not just go with average performance and a lower fee structure?
  • Here’s How Much Fees Matter – Fees are so important to the final outcome of an investment plan and yet, people tend to focus on investments that are simpler, more widely advertised, or just easier to find. Let’s consider a realistic scenario showing what a huge difference fees make. If you take a typical bond fund that has a 1.5 percent expense ratio and it returns 5 percent per year over a long period of time, that’s only 3.5 percent net of fees. When you add in that inflation may have been 2.5 percent each year, now you’re talking a total real return of just 1 percent. That doesn’t sound like much! Now, if you have been going with a 0.5 percent index fund or ETF, your real return would be 2 percent. That’s doubling the real return of your investment over time! Who wouldn’t make that tradeoff?
  • ETF Warning Signs – There are a few things to watch out for with ETFs since they’re not perfect either. Some ETFs actually have high fees. Watch out for the fee structure and don’t always assume that all ETFs have low fees. Some ETFs have stocks or bonds in them that you may not expect or they may not be as diversified as you’d think. Check online to see what their holdings are and see how the performance matches up with prior performance. ETFs can also be traded much more easily and quickly than funds. Be careful not to give up all those savings in low fees by trading a lot and generating tax issues and commissions for trades. The whole premise of trying to beat the market is the final return at the end, net of all fees.

The information in this article is provided for education and informational purposes only, without any express or implied warranty of any kind, including warranties of accuracy, completeness or fitness for any particular purpose. The information in this article is not intended to be and does not constitute financial or any other advice. The information in this article is general in nature and is not specific to you the user or anyone else.

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Darwin is an engineer and MBA who takes an "evolutionary" approach to finance, writing about adapting to evolving financial management, tax, investing, and savings opportunities. Making more money and saving more money is an adaptive process - join the evolution! He blogs at Darwin's Money and ETF Base.
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