Sunday, September 16, 2007

Why Managed Funds are Bad for Your Wealth

We are bombarded with advertisements for managed fund (mutual fund) investments. They implore us to entrust our hard earned cash to them with the promise that their expert managers will reward us with above average returns.

On the face of it managed funds do appear to offer benefits. They allow the smaller investor to diversify (and thus reduce risk) to a much greater degree than if they invested in individual stocks. A managed fund can spread an investment across 30 or more stocks whereas the small investor might be limited to just 2 or 3 by direct investment. And they should ensure that the stocks are being chosen by intelligent individuals with access to the latest and best information.

But all of this comes at a cost, ie the managers commission.

And theres the rub. By the time the managers fees are taken out the average returns dont beat the the market average.

An example of this is reported by the U.K. Daily Mail (Oct 25, 2006) - Research from independent advisers Bestinvest shows that over the past three years 73pc of actively managed funds investing in UK companies to increase your capital have failed to beat the FTSE All Share Index.

As a further example, Clive Briault of The United Kingdom Financial Services Authority says: Our research shows there is no evidence, on average, over time, that actively managed funds outperform tracker funds if you take into account the difference in charges between the two. (The Mail on Sunday, Financial Mail, January 28, 2007)

Burton Malkiels classic A Random Walk Down Wall Street describes academic analysis that says the same.

Of course there are star performers, but these may be explained by chance. Of all the gamblers playing the casino slots, some will (by chance) emerge as winners. It doesnt mean they can repeat their success. Thats why funds carry the wealth warning that past performance is no guarantee of future results!

Best way to achieve the benefits of diversification is through low-cost tracker funds or Exchange-traded funds (ETFs).

Johnny Finnis is editor of, a simple and unbiased introduction to finance and investment for ordinary people to make the most of their money. Have your say on our blog