Fool Australia

Whisper it loudly…the majority of actively managed funds fail to beat the returns of the index.

We have more about “the index” below, but suffice to say this is a damning insight into the ability of those highly paid investing wizards to whom many people entrust their money.

Most of them are rich, but the majority of them are simply not up to scratch. So next time you look at a statement from your Provincial Aggressive Equity Fund or your DUD Conservative Growth Fund, bear in mind there’s a decent chance your money underperformed “the index”.

Don’t believe us?

This is from Standard & Poor’s Index Versus Active Funds Scorecard: Australia Mid-Year 2010…

Over the five-year period ending June 30 2010, a majority of active funds across most of the peer groups in this study have failed to beat their respective benchmarks.

The S&P/ASX 200 Accumulation Index has outperformed approximately 65% of active Australian Equity General Funds over the last five years, increasing to a larger majority of around 72% over the last year.

And this from The Australian in February 2010…

A huge marketing effort in the financial services industry goes to great lengths to convince investors that active funds management works: that the teams assembled at the big brand-name fund management houses have unique skills, information sources and processes to “beat the market”… Some can beat the market — but plenty fail.

And this from Vanguard Investments Australia in The Case For Indexing…

Typically, active managers believe that their extraordinary skill, perhaps mixed with good luck, will generate above average returns. But aspirations aside, how have these active managers actually performed in the Australian managed investment fund market?…on average indexing’s low-cost advantage offers the opportunity for long-term outperformance relative to a majority of actively managed funds.

And finally, this quote from Charlie Munger, Warren Buffett’s partner at Berkshire Hathaway…

The poor guy in the general public is getting a terrible product from the professionals.  I think it’s disgusting.

The time to fight back against the professionals, against “the industry” is now.

Introducing…

The Humble Yet Extraordinarily Efficient Index Tracker

Welcome to “the index”.

An index tracker is a fund that copies one of the main stock market indices (like the S&P/ASX 200, for example) so that by buying into an index tracker, you can buy the overall market without having to pick individual shares.

The S&P/ASX 200 contains the two hundred largest companies on the Australian share market, with each company weighted according to its market value. This means movements in large, usually more stable companies like BHP Billiton (ASX: BHP), Commonwealth Bank (ASX: CBA), Woolworths (ASX: WOW) and Telstra (ASX: TLS) affect the S&P/ASX 200 index much more than smaller companies.

Index investing is perfect for investors who just want the benefits of share ownership without either the hassle or the risks that are inherent in picking your own shares.

We’d even go so far as to say they should form a core part of any investment portfolio. But if you want to try to beat the returns of the index, you’ll have to pick your own shares, something we love doing at the Motley Fool.

Index trackers charge less than other funds. A good index tracker will cost you around 0.75% a year in charges whereas an actively managed fund, like the type we bagged above, where a fund manager chooses shares for you, will set you back around 2% a year, plus some whack you with an initial charge 5% for investing your money in the first place.

Charges make a big difference. John Bogle, founder of Vanguard Investments, puts it this way…

Over an investment lifetime, it turns out that the miracle of compounding returns is overwhelmed by the tyranny of compounding costs, and the investor ends up not with 100 percent of the market’s return but maybe as little as 25 or 30 percent, believe it or not, over 50 or 60 years.

Index Tracking Exchange Traded Funds (ETFs)

Exchange-traded funds (ETFs) are becoming more and more popular in Australia. Many of them are essentially index tracking funds. But, the main difference between an ETF and a plain-wrapper fund we introduced to you above is an ETF can be bought and sold on the share market, whereas a fund is bought and sold from a fund manager.

Got it?

At first, the concept might be a little difficult to grasp. And you might be thinking, why bother having index tracking ETFs and index tracking funds?

In general, index tracking ETFs have even lower costs than index tracking funds. As ETFs are traded on the share market, you can also start off by investing smaller amounts than you’d typically invest in a fund, the latter often requiring a minimum of $5,000 to get started.

On the flipside, once you have your fund set up and running, you can start a regular investment plan with as little as $100.

Index Tracking Fund or ETF?

Which one is for you? As a rule of thumb, for a one-off lump sum, we’d suggest an index tracking ETF is for you. But if you can invest a minimum of $5,000 up front, and you are looking to invest smaller, regular amounts in the years ahead, an index tracking fund is for you.

The Bottom Line: Buy The Haystack

The Motley Fool is all about encouraging you to take control of your own money and make better financial decisions.

The evidence is clear when it comes to investing in actively managed funds. Don’t risk it. The majority under-perform the returns of the humble index tracker.

Having said that, obviously there are some outstanding funds out there. They have skilled managers and great past-track records. Finding them is the easy part. Working out whether their track record in the future will be as good as it has been in the past is the hard part.

As John Bogle, admittedly talking about the US market, says in his wonderful The Little Book of Common Sense Investing…

The simple fact is that selecting a mutual fund that will outpace the stock market over the long term is, using Cervantes’ wonderful observation, “like looking for a needle in the haystack”. So I offer you Bogle’s corollary: “Don’t look for the needle in the haystack. Just buy the haystack!”

The index tracking fund or index tracking ETF is your haystack. If you’re Fools like us, you’ll now want to find some great individual shares to add to your stack. As well as potentially helping you beat the returns of the index, the holy grail of investing, it’s also fun.

Remember our Foolish motto?

Educate, Amuse, and Enrich.

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Whisper it loudly…the majority of actively managed funds fail to beat the returns of the index.

We have more about “the index” below, but suffice to say this is a damning insight into the ability of those highly paid investing wizards to whom many people entrust their money.

Most of them are rich, but the majority of them are simply not up to scratch. So next time you look at a statement from your Provincial Aggressive Equity Fund or your DUD Conservative Growth Fund, bear in mind there’s a decent chance your money underperformed “the index”.

Don’t believe us?

This is from