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Should you change the way you invest after the Neil Woodford Equity Income saga?

Neil Woodford hit the headlines again last week with the closure of his Equity Income Fund, marking an end to the uncertainty faced by a huge number of his investors since it was frozen back in June.

I won’t repeat the details of the closure here. Instead, I’m approaching things from another angle — namely, should the whole sorry saga motivate private investors to change strategy and move away from managed funds? There are arguments for and against, so let’s start with the former.

On the one hand…

A simple argument for continuing to invest with professional money managers is that they can do very well for savers, particularly those who are time poor, or are uninterested in the intricacies of investing.

Whether you attribute it to luck or skill, Woodford was, for many years, a star performer. Between 1998 and 2014, he achieved an annual return of 13.2%. Unfortunately, this track record will now forever be overshadowed by some frankly bizarre decision-making while at the helm of Equity Income (which included continuing to charge fees while it was suspended). 

There’s also something to be said for the fact that some funds provide exposure to parts of the market that can be very volatile, such as micro-cap stocks. While returns from minnows can be nothing short of incredible over the very, very long term (and that’s why I think young investors should always consider allocating some of their capital to them), it can be a lot easier to let a fund manager sift for gold.

On the other…

As a general rule, it costs more to invest in a managed fund than one run by a machine. That makes sense to a point, since you’re paying someone to use all their knowledge and skill to outwit the market. Simply plugging into market performance through exchange-traded funds should cost less.

The trouble with this approach is that the costs incurred from the former end up being a significant drag on returns over time. Counterintuitively, merely tracking the market (but paying a relatively small fee) can actually work out a lot better for investors.

Secondly, managed funds frequently underperform the benchmarks they’re required to beat, sometimes even before the aforementioned fees are taken. A winning fund can also quickly become a loser — such is the difficulty of finding a manager that consistently outperforms. I greatly admire the stock-picking prowess of Terry Smith, but it’s worth pointing out his massively popular Fundsmith Equity Fund is still to be tested by a market crash. 

If you’re committed to understanding the markets, there’s a lot to be said for learning to pick stocks yourself. This doesn’t make it any easier to outperform but it does allow you the freedom to follow your own inclinations rather than hoping for the best with a professional who is arguably just as susceptible to fear and greed as you are. On which note, there’s no guarantee they’ll stick to their investing style in an effort to chase returns. That’s essentially what happened with Woodford. 

All told, while I think there’s still a place for managed funds, the arguments for adopting a do-it-yourself and/or passive approach to investing are very persuasive. Remember that no one cares as much about your money as you do. 

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.