Picking the Best Funds
The Index Fund
The crucial difference
between an index and managed mutual fund is that an index fund simply holds
the same stocks that are in a particular index, rather than employing a
manager to pick what he or she thinks will be the best-performing stocks.
An index fund attempts to match the performance of an index, not beat it.
Index funds
don't try to beat the market because they are based on the belief that
it is a more reliable strategy to simply keep costs low, rather than try
to be too clever. Index funds tend to be very good at keeping costs down,
often fees are less than half (sometimes a lot less than half) of what
a managed fund charges.
Managed funds
are based on the belief that through careful analysis, stocks selection
or market timing that superior returns are possible. They are necessarily
more expensive than index funds because they employ a lot more workers
to carry out this research, often very highly paid ones. In addition, many
managed funds have higher marketing expenses, because unlike index funds
which compete on fees, actively managed funds compete with other managed
funds to impress people with their performance and corporate image, which
means index funds usually have low key marketing efforts since a good one
"sells itself", while managed funds spend a fortune on TV advertising and
glossy brochures, not to mention incentives to financial advisers such
as trail commissions and marketing support.
At first glance,
this might sound like a recipe for mediocrity. But don't believe it. Index
funds are actually better performers than most actively managed funds,
and thus better choices for most investors. Historically, most index funds
have beaten the vast majority (often over 75%) of all active funds. The
reason for this is costs.
So, what's
best for you? Since fees leave most funds underperforming the market indices,
the key is to find a fund that at least matches the market and has minimal
fees, i.e., go for index funds.
Managed
funds vs. index funds
If you have
been investing in actively managed funds over the past few years utilizing
dollar cost averaging of an amount of RM1,000 monthly, your money will worth over much less now than if you had invested in an index fund. See table below:
| |
Equity
Fund Growth |
Equity
Fund Income |
Index
Tracking Fund |
| 5
Year |
RM
75,739 |
RM
75,741 |
RM
77,842 |
| 3
Year |
RM
44,137 |
RM
44,451 |
RM
46,031 |
| 1
Year |
RM
13,592 |
RM
13,470 |
RM
14,212 |
|
source: Personal Money Lipper's Fund
Performance Ranking Tables as of Jan 2005
That's a more
than 2.5% underperformance for the average actively managed fund. A little
under two percentage points might not sound like much, but it adds up.
After some years, the market-matching account would be much bigger than
the average actively managed account.
And that kind of
money can be the difference between a comfortable retirement and working
at the local McDonald's. |
