When it comes to planning and securing your financial future, investing is a critical step you need to take. The question is not whether you should invest, but how you should invest. This article will explore the active style of fund management and the passive style, ultimately suggesting which is better for your financial wellbeing.
The perceived power of active management
Let’s face it, Fund Management is a powerful industry.
It lobby’s hard to protect its interests. Various companies spend lots of money on advertising, and there is a vast source of financial media. These media platforms such as Bloomberg are largely funded by the companies who manage funds. The financial media has a need for stories, and professional investors are more than happy to provide them, further pushing their interests.
Active Managers are even more powerful in the fund management industry because individual investors like you and me believe that active managers have superior skill, thus can achieve superior results. We are willing to pay extra for this service, but we fail to realize this one truth: the higher the fees paid, the more the returns dwindle.
It’s a loser’s game
When it comes to investing, it’s downright scary. In the U.S., pension plan fees are typically high and hard to accurately calculate. Most people end up paying a lot for retirement services for one of two reasons:
1) Individuals simply do not know they are being charged excessive fees
2) individuals simply do not care how much they pay as long as they realize a return.
This concerning statement stems from the fact that when planning for retirement, you typically start at a young age. At that point, retirement feels very far away, so you may be less concerned with fees. While many pensions state their annual charge, they fail to list out individual fees.
This needs to change. Financial uncertainty is bad enough, through in high fees and it’s a recipe for disaster.
How to Win
There needs to be more transparency and fairness in terms of securing your financial wellbeing for the future. Active managers may charge up to 1%-2% in management fees, yet you never know what the transaction costs will be (that is not a reported number). Trading costs, the compounding effect of annual fees, and taxes take a large chunk out of your savings.
That’s the problem with active management. Trading costs are much higher than in passive investing because active managers go in and out of securities all the time, hoping to beat market corrections. On the other hand, passive funds are cheaper to operate and do not buy and sell securities nearly as often so it makes sense that passive funds charge lower fees.
We pay active managers to deliver more than the market return, but do they really do this? In short, not consistently.
As founder of Vanguard, John Bogle, says
Funds have a tendency to return to the mean—one year the fund will greatly exceed the market return, but the next it will fall well below, thus maintaining a market average
While some active funds appear as excellent tools to grow your money, it is simply not sustainable.
The general consensus is that 100% of fund managers will say they can do better than the market, but only about 1% will actually outperform the market on the long term. This is a problem, individual investors are paying excessive fees for professionals to actively manage their money, yet lose their financial gains to these costs. In order to maximize returns, cut out the active manager and invest your money in passive funds. It will cost you less, thus adding to your prosperity in the future.
At M3 Wealth Management we believe your asset allocation is the greatest driver of investment return. The key is to determine your goals: What’s your investment duration? What risk level can tolerate to maintain confidence when markets decline. Once you know these questions, it is best to implement that asset allocation with low cost index funds and exchange traded funds.
To map out your goals or determine your risk profile click the button below for a free assessment.