Should you try and beat the market by buying an actively managed fund, or should you just buy the FTSE 100 and FTSE 250?
This is a question that’s been facing investors for some time, and has been labelled as “the great debate” by some analysts.
To solve the question, Jack Bogle — an index fund pioneer and founder of Vanguard — recently set out to prove that indexing is the best way to go for most investors with a series of charts.
Bogle’s figures revealed that, thanks to fees and charges alone, the average actively managed US equity fund will underperform a standard, low-cost tracker fund by 2.64% per annum.
Now, an extra 2.64% per annum might not seem like much, but the additional returns really stack up.
Indeed, Bogle’s figures showed that over 50 years a $10,000 investment compounded at 6.64% per annum — the standard tracker return — would turn into $248,000. However, $10,000 compounded at just under 4% for 50 years — a return including active management fees — would turn into $70,387.
That means that due to excessive management charges, investors who put their money to work in actively managed funds would have lost out on $177,610 worth of gains over the period studied.
Slow and steady
Other research also supports the argument for indexing.
Over the past 29 years, the FTSE 100 has returned around 5.5% per annum, excluding dividends. Meanwhile, the FTSE 250 has outperformed its blue-chip peer by around 90% excluding dividends. And finally, the FTSE All-Share has returned closer to 6% per annum. Including dividends these returns would be closer to 10%.
On the other hand, according to research conducted by a number of financial institutions, the average private investor has only returned 2.5% per annum including dividends.
What’s more, with an estimated 80% of active fund managers failing to beat the market, it’s easy to conclude that tracker funds are the best way to go.
There are some very low-cost trackers out there for you to take advantage of. For example, the BlackRock 100 UK Equity Tracker, Fidelity Index UK and db x-trackers FTSE 100 UCITS ETF (LSE: XUKX) all charge a lowly 0.09% per annum in management fees.
For the FTSE 250, the iShares FTSE 250 UCITS ETF charges an annual management fee of 0.4% and the HSBC FTSE 250 Index fund charges around 0.3% per annum.
Low-cost FTSE All-Share trackers include the Vanguard FTSE UK Equity Index, which charges 0.08%, Fidelity Index UK which offers index replication for 0.09% (0.07% if purchased through Fidelity) and the Legal & General Tracker Trust charges 0.10%.
The income problem
Unfortunately, while index trackers may be a low-risk, low-cost way to grow your wealth over time, income investors are likely to be disappointed.
Indeed, the HSBC FTSE 250 tracker only offers a dividend yield of 2.2% and the BlackRock 100 UK Equity Tracker’s dividend yield stands at 2.6%.
So, if you rely on your investments for additional income, then it could be sensible to buy a selection of dividend champions to sit in your portfolio alongside a low-cost tracker.
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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.