What is the very least that we private investors should expect when we invest in the stock market? Is it enough to simply hand our money over to fund managers and hope that they will try their level best for us? Some investors do. Some investors believe that letting other people manage their investments could be a good idea. They might do so for a variety of reasons. These could include a lack of investing expertise, a lack of market knowledge or simply because they don’t have the time to manage the investments themselves. But study after…
Is it enough to simply hand our money over to fund managers and hope that they will try their level best for us?
Some investors do.
Some investors believe that letting other people manage their investments could be a good idea. They might do so for a variety of reasons. These could include a lack of investing expertise, a lack of market knowledge or simply because they don’t have the time to manage the investments themselves.
But study after study has shown that over extended periods, the average actively managed fund can’t beat the market.
How is it possible, you may ask, that professional fund manager can underperform the market? After all, aren’t they supposed to know what they are doing?
You are right. Most of them do know what they are doing. But the reason for the underperformance can often be traced back to the fees that they charge (that you pay) for looking after our money.
Thing is, fund managers, in the main, don’t like to deviate too far from the market average. That would make them look ridiculous. Consequently, they will try their best to mimic – as closely as possible – the performance of the index that they are being measured against.
What that really means is they might buy many of the stocks that make up the benchmark index. In the case of the Straits Times Index, it could mean buying lots of SingTel (SGX: Z74), oodles of DBS Group (SGX: D05), a big dollop of OCBC (SGX: O39) and a whole heap of UOB (SGX: U11).
That helps to, at the very least, closely match the returns from the benchmark.
But there is problem with the seemingly simple strategy. After charges are included, the investment returns could lag the benchmark by a couple of percentage points every year.
That might not seem too damaging at first. But a couple of percentage points lopped off your returns year after year soon mounts up to a lot of your money.
Some fund managers, though, dare to go out on a limb and try something a little different to beat the benchmark. But a recent study revealed that only two out of 2,862 mutual funds could consistently achieve top-quartile performance over five successive years.
Top quartile means the top 25%.
I don’t know about you, but that strikes me as being quite appalling. If as a young student, I was to go home and tell my parents that I was one of the top 25 out of a class of 100, I doubt if they would be too impressed.
And if I was to tell them that I couldn’t even make the top quartile for five successive years, I think the might be quite horrified.
Truth is, we can all do better than that.
If all you want to achieve are the market returns, then a simple low-cost stock market index tracker such as the STI ETF (SGX: ES3), which mimics the market, should suffice. And it won’t even cost you an arm and a leg in charges.
But if you want to beat the market, there is no reason why you can’t buy a basket of good shares and just hold them for the long term. Avoid chopping and changing your selections too frequently because that will inevitably incur transactions costs and lower your returns.
But most important of all, don’t forget to reinvest the dividends because that is the easiest way to boost your total returns.
A version of this article first appeared in a SIAS newsletter.
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