If you are new to investing, it's very easy to think "How can I compete with professional fund managers? Surely, I am better off investing my money in their funds and letting them make the decisions".
This assumes that professional fund managers are good at their job.
Let's be clear: there are some outstanding managers running some high-performing funds and investment trusts. Identifying these people before they make most of their gains is very difficult though. It's also often the case that today's star fund manager can't maintain their previous winning run. For private investors like us it then becomes quite hard to work out whether a fund manager's past performance has been due to their skill or just plain luck.
Unfortunately, there are also lots of managers who aren't doing very well. Many are doing a worse job than a cheap tracker fund - a fund that aims to copy the performance of an index such as the FTSE All-Share rather than beat it - which is mainly run by a computer.
However, there is also a lot of nonsense written and said about fund managers as well. Despite what you might read in the mainstream media, they are not a bunch of dishonest and incompetent people. The problem with handing your money over to a fund manager and why you can do just as good a job yourself-or better - boils down to two main flaws:
Like most businesses, fund management companies exist to make money for their owners. In very simple terms, fund managers make money by charging customers a fee for looking after their money. This fee is usually a percentage of the customer's investment account. The bigger its value, the bigger the fund manager's fee. You might think that this is a good arrangement as it incentivises the manager to pick winning shares that grow the value of your savings. Sometimes it can be, but often it actually leads to a different type of behaviour.
The fund managers know that their income - and their job - is dependent on their customers staying with them (to keep the pot of money and therefore the percentage fee as high as possible) and not switching their money to another manager. The easiest way for customers to leave is for the fund manager to underperform the stock market they are trying to beat.
In order to avoid this, many fund managers have deliberately built their portfolios to look like the stock market they are benchmarked against (these funds are known as closet trackers in that they are saying they are trying to beat the market but are essentially making sure that they don't deviate from it too much). They will buy what the herd is buying and if they fail then they are not alone. This is a lot better for their job security than straying from the herd by picking a cheap share that takes time to pay off and leads the manager to underperform the market. However, this avoids one vitally important point:
To beat the stock market you must invest differently to it!
If you are managing your own portfolio, you don't have to engage in these silly games. You shouldn't even be concerned about beating the stock market too much. Your focus should be on using a share portfolio to grow the buying power of your money so that it will buy more things for you in the future than it will today.
You don't need to own dozens or hundreds of different shares like many professional fund managers do. That's far too many. I'd argue that you can achieve very acceptable results with 15-20 different shares at most. You need to spend your time investing in good companies at attractive prices. You'll struggle to find hundreds of shares that meet these criteria at any one time. By concentrating your efforts on finding them and avoiding bad ones, you are well on the way to becoming a successful investor. Owning a share because it is a big part of an index doesn't make a lot of sense if you will struggle to make money from it.
On your own, you are free to invest in any company. Fund managers, because of the huge funds they manage, can find it difficult to invest in smaller companies. The minimum stake they might invest could still represent a huge, controlling interest in a small company. Additionally, the size of the trades could excite other market watchers and bid the price up - making it harder for the fund manager to buy shares at a reasonable price. For this reason, professional analysts may not even bother researching companies below a certain size.
There can be great opportunities for investors within this sector of the market. Because many smaller companies are often ignored, you have a chance to find exciting growth companies before they get onto the radar of the professionals. This is the realm of "ten-baggers" - stocks with the potential to grow ten-fold in value.
Your second advantage is that you can move your money into cash any time you like. If you think stock markets in general, or a particular market like bonds, are heading for a big fall you can sell your investments and buy back in when prices are much cheaper. Many fund managers have to stay fully invested in shares even if they think valuations are too high.
On top of these issues, there is another big problem - high fees.
There is nothing more damaging to the health of your finances than paying too much money to managers every year. Over the years, these fees add up and eat away at your savings pot. You end up a lot worse off In the future than you should have done.
The fees that professional money managers charge have been coming down but they are still too high. The other problem for customers is that the fees are not clear. Very few funds will really tell you how much their investing activities actually cost you.
Investors will be quoted figures such as an annual management charge (around 0.75% per year for a professionally managed fund of shares) or a total expense ratio (TER) - costs including the annual management charge and others such as administration which might add up to 1% of the customer's account value). Both these figures understate the true cost incurred by customers by giving their money to a professional fund manager. The costs of buying and selling shares (commissions, the difference between the buying and selling price of shares and stamp duty) are not included and they should be.
Terry Smith - who runs fund management company FundSmith - is more open than most of his peers. He reckons that the all in cost of investing in his fund is 1.2% per year compared with 2.25% for the average managed fund (it is higher because the average fund manager buys and sells a lot more than Smith does). Over the last few years the performance of his fund has justified this cost. The same cannot be said for many others.
Can you really afford to give away 2.25% a year?
Despite its many flaws, the performance of professional funds during the last five years looks pretty good - at first glance. According to the Trustnet website, in the five years to the end of February 2015, the average fund invested in UK shares had grown by 63.9% (including dividends reinvested). A Vanguard FTSE All-Share tracker fund had grown by 55.3%. Of the 237 funds with at least a five year track record, 151 of them did better than the Vanguard tracker fund. Surely this is hard evidence to say that professionally managed funds are worth the extra money?
Not so fast.
Like most of the world's stock markets, the UK's has been on a stellar run during the last five years, especially the shares of smaller and medium sized companies. In fact, the iShares FTSE 250 exchange traded fund (a passive fund that tracks a basket of medium sized companies) has grown by 98.2% - only 27 funds beat that.
So should you just put your money in a cheap tracker fund? That's one option SharePad can help you research. Another is to take control of your own money and become your own fund manager.
SharePad enables you to be your own fund manager. It's not easy but if you follow a few simple rules you can beat many professionals and build up the size of your nest egg. You need to possess a lot of different characteristics to be a good money manager but I can think of three that are essential:
The first two are down to you, the third is where SharePad comes in.
SharePad provides you with everything to need to find winning investments. You can search through hundreds of UK and US shares to fit virtually any criteria you can think of. If you want to invest in funds then SharePad can help you with that as well.
If you decide to invest in individual shares, with SharePad you can perform an in-depth study of a company's financial history and its valuation in minutes. It will work out a lot of useful calculations for you so that you can really understand what makes a company tick. You can also find out what's been going on with the company recently with SharePad's news function. We think you'll find SharePad an invaluable tool in helping you get the most from your investments.
However, we've decided to do more than just provide you with a useful bit of investment software. On top of that we are providing all users with a Step-by-Step Guide to Investment Analysis to help you understand all the numbers you'll encounter and how to put them to good use. We'll also be writing lots of helpful and topical investment articles which you'll find here on our website. So if you are a growth investor, value investor, looking for dividend paying shares or want to buy bonds or funds we've got it all covered with SharePad.
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