I’ve got more money in managed portfolios (mutual funds) than I do in index funds at this point in time but that’s a trend I’m actively seeking to reverse.
Does that mean index funds (sometimes know as index trackers or tracker funds) are better than managed portfolios?
In my opinion it depends on what type of investor you are and your level of confidence with, or desire to, self manage your own investments.
On top of that the other big factor to consider when deciding between an index fund or managed portfolio are the fee’s associated with each.
It might be that you decide you want exclusively one or both types of investments in your overall portfolio but to get to that decision point let’s look at the key considerations with index funds vs managed portfolios.
Index Fund Fee’s vs Managed Portfolios: Comparison
If you’ve done any background reading on index funds then you likely already know that one of their biggest draws is the low fee’s you pay to hold them as an investor.
Vanguard, founders and the number one proponent of the index fund, currently offer their S&P 500 ETF (an index of the top 500 US companies) with an ongoing charge of 0.07% to investors.
With an initial investment of £100,000 and an annual return of 6% over 10 years your fund would be worth £177,906 and the ongoing charges would cost you £920.
St James’s Place, a well known UK based wealth management firm, offer their SJP Allshare Income fund (a managed portfolio which invests in UK companies) with an ongoing charge of 1.86%.
They also have a 5% entry charge.
With the same £100,000 investment over a 10 year period averaging a 6% annual return your investment would be worth £142,528 and you’ll pay £26,353 in ongoing charges.
The managed fund costs you £26,353 vs £920 meaning the index fund is a staggering £25,433 cheaper to hold.
Remember you pay your ongoing charge for both types of investments regardless of performance.
*If you’re buying any investment through a wealth manager or independent financial advisor they’ll often add their own ongoing charge to the investment as well so be sure to look out for this and factor it in.
Key Point: Index funds are way cheaper to hold, ongoing charges are a fraction of the cost and they usually don’t charge entry fees. The only way for managed funds to justify their fees is to beat the performance of index funds. This rarely happens with 77.97% (as of Jun 30 2020) underperforming vs the S&P 500 index.
Why Do Managed Funds Have Such High Fees?
In theory, the reason charges are so high is because the funds are actively managed (with the goal of beating the market) and therefore there’s a whole team of data analysts and an overall fund manager moving investments in and out of the fund in an attempt to maximise profits.
Your wealth manager or independent financial advisor will likely tell you that this is a service worth paying for (in my experience managed funds are what they like to put clients in) however historical data does not support that claim.
When you compare index trackers vs managed funds there’s a key difference. Index funds are managed by computerised systems which automatically buy and sell investments based on the fund perimeters.
For example if a company drops out of the top 500 largest in North America and you own Vanguards S&P500 index fund then its shares are sold and automatically replaced by the new company. As the process is automated the fund is much cheaper to run.
Are The Fee’s Worth Paying?
A good way to measure if fee’s are worth paying on managed funds is to compare the performance of the managed fund vs the overall market index.
This is easily done.
Just look at the performance of any total market index fund, I’ll often use Vanguard’s Total Stock Market Index Fund (VTSAX) and compare it to that of the managed fund in question.
St James’s Place Global L fund is fund targeted at investing in global shares in order to maximise profits for their investors. Its cumulative performance over the last 10 years would have resulted in a 176.88% increase in your money invested. Over the same time period Vanguards Total Stock Market Index Fund would have returned you a 174.65% return.
If you’d had £100,000 in both funds you’d be at £276,880 with St James’s Place and £274,650 with Vanguard (a difference of £2,230 in favour of SJP).
HOWEVER… add the fund fees and minus them from your profits and it’s a very different story.
The St James’s Place fund charges 1.74% in ongoing fees and a 5% entry fee. That would be a total of circa £51,846 in fees over the investment term meaning you’d be left with £225,034.
The Vanguard index fund has a charge of 0.04% and no entry fee. This would result in circa £14,633 in fees leaving you with £260,017. A respectable £34,983 more than the managed fund.
Wealth managers and financial advisors don’t like to answer questions about those comparisons or talk about fees in general (if yours does you know you’ve got a good one).
Believe me I’ve tried.
This is because, for the most part, it’s impossible to justify putting your money into managed funds when it comes to pure financial gain but they favour managed funds as the kickbacks are better.
*Some managed funds do outperform the market but it’s very hard to predict which will as historical performance is no guarantee of future success. Unless you’ve got a specific reason to believe your fund manager will do better than the market average you may want to considering index fund investing.
Are Managed Funds A Rip-Off?
I can certainly understand why to some it might look that way, given the high fees and lack of ability to beat the market average over time, but I still don’t think they can be considered a rip-off.
These funds do have a cost to run and the institutions running them have wages to pay. The entire team behind a specific fund are trying their absolute best to beat the indexes and justify their positions. The problem is it’s an uphill battle very few seem to win.
Why Buy Managed Funds At All?
As you’ll know from this posts intro, I have more money in mutual funds than I do in index trackers at present.
The reason for this is simple. When I was a significantly less knowledgable investor I was sold these funds by financial advisors and wealth managers.
It was also a number of years ago when it wasn’t so easy to set up your own investments online.
Do I hate or curse these guys for selling me into these funds? I categorically do not. They have still made money. Just not as much as index tracker funds would have.
So if that’s the case why buy managed funds at all?
- You’re New To The Game – if you’re a beginner there’s a lot of mud and jargon to wade through before you start to formulate a true understanding of the types of investments that are available and how to buy them. You can sit down with an advisor, asses your appetite to risk, sign a couple of documents and get your money into the market quickly without worrying about messing anything up or having to manage the situation at all.
- Your Attitude To Risk Is Low – index funds tend to sit quit a bit higher on the risk scale than managed portfolios as they contain 100% stocks and shares. Managed funds can be structured for any risk appetite (often including government bonds and currency in an attempt to de-risk) and that is going to suit some investors.
- Financial Advisors Relationship Perks – when I say relationship perks I’m not talking about the odd golf day, I’m talking about actual advice. Good IFA’s and wealth managers can often provide tax planning tips or have knowledge of tax efficient means of investing beyond what your accountant can tell you. I’ve saved tens of thousands over the years thanks to these exact relationships.
*By the way… a low appetite to risk when investing is nothing to be ashamed of. Over exposure to risk can cause investors to make a number of mistakes which can ultimately cost them dearly. Pulling money out of the market in fear of the market dipping is the most common blunder but it happens all the time. Invariably amateur investors get it wrong, the market doesn’t dip, it rises and they miss out on the gains.
Index Trackers vs Managed Funds: My Verdict
I’m at a point now where I’m comfortable handling my own investment decisions and, for the most part, I know where to actually make those investments. For those reasons I’m looking to rebalance in favour of index funds as much as I can.
If I had a good advisor who could put me into the index funds I want, I’d be all over it, as self managing is a time consuming task.
I am however going to keep some of my mutual fund investments to maintain the benefits from the relationships they’ve allowed me to build.
Ultimately the ongoing charges sway me towards favouring index fund investing but you should make your own decisions and give serious consideration to the benefits that holding some money in managed portfolios can give you.
Don’t be overly influenced by the many online publications and 25 year old Youtuber investors calling scam the minute they hear the words managed fund. They do have some benefits and as long as you understand the difference and have solid reasoning for your decisions you can be happy with the choices you make.
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