Passive investments such as ETFs can be a great choice for ordinary investors. But be wise with your cash. Make sure you’re getting the maximum benefit from your investment by avoiding unnecessary fees.
Money managers aren’t worth the cost. That’s Warren Buffett’s view, anyway. And when the Oracle of Omaha offers his opinion, the investment world takes notice.
Buffet has started singing the praises of passive tracking funds, which are designed to offer lower fees than actively managed investment funds.
It’s easy to understand why. Passive funds are an excellent way for ordinary investors to seek competitive returns at a reduced cost.
That’s why if you do choose a passive investment, such as an index-tracking ETF, you should ensure that you are paying commensurately lower fees, in order to get the full benefit from your investment.
Any additional costs, such as for an intermediary to choose your investment allocation, should be carefully weighed up in order to determine whether you’re really getting the best value.
What is passive investing?
Active investments refers to funds run by money managers that aim to outperform the market. Based on the arcane art and science of investing, the portfolio management team will try and anticipate movements in the market, and buy and sell securities in an attempt to maximise returns.
Passive investments, by contrast, are designed to track the performance of a given index, such as the S&P 500 or the top 40 companies listed on the JSE. ‘Passive’ doesn’t indicate that nobody is paying attention to your investment or that the portfolio simply comes into being on its own. Rather, the managers overseeing the investment deploy a system designed to replicate the performance of the relevant index, rather than continually make decisions about which securities to buy and sell. One obvious benefit of eliminating the money manager is eliminating the money management fee.
There is no consensus on which investment approach is superior. Money managers will insist their unique experience and insight will lead to better returns. On the other hand, money managers are fallible human who can also make bad investment decisions.
We certainly will not be able to settle this complex matter now, but for most of us, it’s enough to know that tracking funds are a great way to seek higher returns with lower charges, and therefore an investment option worth considering.
Getting the most out of your passive investment
As with any investment, two fundamental considerations when choosing passive investments are asset allocation and cost. ETFs can be an effective means of diversifying your portfolio at a relatively low cost.
Passive doesn’t mean inflexible. There are numerous ETFs indexing a range of asset classes. If you’re looking for a fund that tracks the performance of equities you could, for example, invest in an ETF that tracks the 40 or 100 biggest companies on the JSE. The performance of your investment would be broadly aligned with the performance of the JSE as a whole.
Investors seeking a more balanced investment can also choose a number ETFs with reduced exposure to equities. In that sense, choosing your risk profile is not fundamentally different from selecting, for example, an actively managed unit trust portfolio.
More experiences investors may also wish to consider ETFs that track specific sectors of the JSE or global equity markets.
Keeping costs down
The potential for lower fees is not the only reason to choose passive investments. Many see absence of an active manager as a feature, not a bug. The clearly defined structure of a tracking fund means that investments are predictable and transparent.
That said, the opportunity to avoid costly management fees is one of the most attractive features of passive investing.
The rising popularity of ETFs is no surprised. They offer a simple, transparent and cost-effective way for ordinary people to invest. But this rise in popularity may also incentivise financial services providers to layer on ‘value-added’ options, such as bundling together a collection of ETFs.
Broker and advisor fees may not seem like much at first, but the cumulative effect can be significant. For most ordinary people, investment is a long-term strategy. That makes it important to consider best possible way to maximise your returns over time, which means balancing risk with potential gains – and eliminating unnecessary fees that can eat into those gains.
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