FOOL'S EYE VIEW
Average Is Better

By Jane Mack (TMFJane)
June 24, 2002

I went to a neighbour's housewarming party on Saturday and was having a very interesting chat with a rather good-looking man about how bad the traffic was on the M4. When we'd exhausted that fascinating subject I asked him what he did for a living and discovered he was an Independent Financial Advisor.

Are you a commission-based IFA or do you charge a flat-fee, I asked? Commission-based, he replied.

At which point I laughed and told him that my job was to write horrible things about people like him.

Okay, that might be a slight exaggeration but we did proceed to have a great discussion about why he spent his life recommending actively managed funds to people when all the evidence indicates that over the long term the simple index tracker is a much better deal.

The truth is that the vast majority of the managed funds that Independent Financial Advisors recommend underperform the humble, computer-led tracker funds. And when we say vast majority, we mean 75% plus! The main reason is the lower charges that you pay on trackers. A typical tracker fund will charge around 0.5% a year in management fees and the majority do not have an initial charge.

Managed funds, on the other hand, tend to charge at least 1.5% a year (plus, in many cases, an initial charge for the privilege of buying one of between 3-5%). Over the years the difference of 1 percentage in annual charges can really eat into your investment. Also, many fund managers spend a lot of their time trying to second guess each other and worrying about their short-term performance rather than concentrating on the long-term. This means that they trade more than they should which in turn means they, or rather you, incur a lot more in transaction charges. All in all, a tricky and expensive business.

Trackers just get on with doing their job of following the overall market nice and cheaply. (Well, computers don't generally need a new Porsche Boxter each year and they don't demand obscene Christmas bonuses either!) They are also a lot simpler and less time-consuming to invest in and you don't have to read the financial pages of the Sunday quality papers each week to check that your star fund manager hasn't been poached by another company.

For the vast majority of the public, a cheap index tracking fund is the ideal long-term investing vehicle. They're cheap, simple and efficient and you don't have to worry about how much of your investment is being eaten away by all those commission charges, initial charges and vast amounts each year in annual management charges. Best of all, you don't have to do any complicated research.

I rather enjoyed my conversation with the IFA although he must have felt that I'd given him an unnecessarily hard time. Admittedly there are some people who really don't want to have to think about how they handle their money so I wasn't condemning financial advisors generally. Sometimes we even recommend them particularly when they charge a flat fee for their services. It removes the risk of them being tempted by high commission payments when choosing where to invest your money.

It's just that there are some facts that you simply can't ignore. Plumping for an index tracker may mean that you're only getting an average return on your investment but sometimes average is better.

More: Index Trackers