(03) 9020 2905Investment Wars, episode whatever. Cue the starting rolling credits.
“In the never-ending battle of good over evil, of investment performance over opportunity cost, for positive returns over capital losses, in the hope that financial dreams triumph over budgetary nightmares …”
Today, I bring you the most powerful investment philosophy of all time. Bizarrely, and sadly, it’s a bit of a secret.
And it’s true beauty? You don’t need to know anything! Not a cracker about P/E ratios. Not a zot about dividend yields. And you certainly don’t need to know anything about inverse yield curves. Promise.
You can earn the same returns as the industry superstar. In fact, you’ll beat more than half of them.
The little secret is called … index investing.
Whazzat? Or, as Gary Coleman (Arnold) used to say in Diff’rent Strokes, “What you talking ’bout Willis?”
Investment managers sell themselves on being able to beat the returns generated by competitors.
Managed funds try to beat other managed funds. Stockbrokers try to beat other stockbrokers. One property guru claims he can beat the next property guru.
You know what? Exactly half of them will beat the other half in any given investment sector. (That’s called a truism.)
And if you’re invested with the winning half, fantastic! You won! Will you win again next year? Maybe. Maybe not. The genius stockbroker/fund manager you picked this year might, or might not, outperform in the second year. How about the third year? The fourth?
These gurus – known as active managers – are paid lots and make big bets to try to be in the top half of performance tables.
Index investing is based on taking the opposite approach.
The index philosophy? You can’t win all the time. Half the time you’ll beat the average. Half the time you won’t. Given that beating the average versus finishing in the bottom half is a 50-50 game at best, flip your thinking.
Focus on cost. Here’s where index investing gets as sexy as Bo Derek, and less drunk than Dudley Moore, in “10”.
The average cost of an “active” manager for an Australian share fund is 1 per cent. An “index” manager charges about 0.2 per cent.
Yup. It’s 80 per cent cheaper to index. Therefore, an “active” fund manager needs to beat an “index” fund manager on overall performance by, on average, about 0.8 per cent each and every year, in order to be ahead.
How many fund managers do that consistently, over periods of 3 or 5 years? Three parts of two-fifths of … not very many.
Don’t take my word for it. Investment uber-guru Warren Buffett thinks you should invest through index funds.
“Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees.”
That’s a Buffett-meister quote from 1996. This is no newfound hippy investment philosophy. The “secret” of index investing was around for decades before Wazza’s uttering.
In essence, index-based investing is low-cost access to the sorts of investment markets that most of us should be invested in. That is, shares, property and bonds.
When is a good time to use index-based investing? When you:
- Know you need to invest, but don’t know much about investing.
- Don’t know much about a particular asset class, such as shares, property or fixed interest, but know you need to have some money in it.
- Want low fees.
- Want your super invested in low-cost funds that will do okay.
- Don’t want your returns eaten up by trading costs.
For the vast majority of people’s investing needs, index investing has got you covered.
But as much as I am a fan, the Superman status of index fund investing has a few kryptonite areas.
Residential property is one. Residential property investing is about gearing and investment control. And it simply can’t be covered by index investing.
Another is cash. If you’re prepared to search through the best deals on the internet, you’ll probably do better.
But why is this an “investment war”?
Because most of the finance industry is actively set up to stop you investing in index funds. The marketing budgets/campaigns of the active managers are HUGE! And, wouldn’t you know, it’s built into their pricing structure.
Bruce Brammall is the author of Debt Man Walking (www.debtman.com.au) and a licensed financial adviser. bruce@debtman.com.au.