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Aim for average

November 19, 2012
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No one likes to be average. Even the least ambitious among us aspires to be good at something.

As a species, it’s a trait that’s served us humans well. But there are areas of our modern lives in which our evolutionary instincts can let us down. And investing is one of them. 

When, in the mid-70s, John Bogle set up the world’s first index fund, he was derided by competitors as “un-American’. Edward Johnson, chairman of Fidelity at the time, was quoted as saying that he "[couldn't] believe that the great mass of investors are going to be satisfied with receiving just average returns". 

Yet Bogle’s company Vanguard, has become the largest mutual fund company in the United States, with around $2.1 trillion of seets under investment. 

You see, investors in the States, unlike most of their UK counterparts, have come to appreciate the value of average. 

The markets can only yield a finite return. For every fund manager whose returns are higher than average, there must be a manager whose returns are lower. 

Of course, in those slick adverts in the money pages and on station platform billboards, the message the fund managers try to convey is that they’re one of the winners - and you will be as well if only you invest in this actively managed fund or that one. 

But the performance tables tell a different story. In the North American equity sector, for instance, not a single actively managed fund succeeded in beating the S&P 500 index in the 12-month period up to 1st October. The top two funds were both index funds. 

In the global equity sector, over the same period, the highest performing fund was L&G’s Global Index Fund. That’s first out of 191. Hardly average. 

But the most important factor which investors with Vanguard understand, and the majority of UK investors don’t, is that what matters most is what returns they make after costs. 

Almost invariably, index funds are cheaper than actively managed ones; in most cases they’re a tiny fraction of the cost. And over time, the effects of compound interest can mean an investor who chooses actively managed funds sacrificing up to a third of the value of their investments

By contrast, a passive investor is guaranteed above-average returns when costs are taken into account. 

What’s more, it takes him or her next to no effort and, as long as their investments are sufficiently diversified to match their tolerance of risk, there’s no need for them to keep checking the markets and performance tables, or waste time fretting in front of CNBC. 

To turn down a proposition like that, you either need to feel very lucky, or have a remarkable faith in your fund manager’s ability to predict the future. 

 

 

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