The simplicity of investing
Doctor Burton Malkiel is professor of economics at Princeton University and has served on the US president’s council of economic advisers. He has devoted his life to studying how markets behave. The lessons, he says, are simple. Markets are, broadly speaking, efficient. You can’t beat them, so fire your financial adviser and put your money into index funds. These are unburdened by investment management costs, so they will always outperform the average active fund. Build an asset allocation model that suits your age and risk profile, then diligently put money in every month until you retire. Annually rebalance your portfolio – selling what’s gone up, and buying what’s gone down. And that’s about it, really.
David Swensen is Yale University’s Chief Investment Officer and one of the most successful institutional fund managers over the last 20 years. Swensen says you should only invest in things that you understand. That should be the starting point and the finishing point. For most investors, this means avoiding complicated alternative investments like equity-indexed annuities, structured investment products and hedge funds. The key to investing is relatively simple and almost boring. Determine the asset allocation that matches your ability, willingness and need to take risk. Then, implement this asset allocation using passive investments that are easy to understand. If you follow this simple advice, you’ll be well ahead of many investors.
The Financial Times reports on UK’s new national pension system (PADA) to be introduced in 2012 in “Fresh thinking key for new pension”. PADA is in favour of the lifestyle approach to asset allocation, where money is moved (from shares) into cash and bonds in the run-up to retirement.
Target-date asset allocation funds represent a simple but financially efficient solution that the majority of retirement plan participants should select to achieve their retirement income goals.
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The failure of active management
Damning research showed that the Satrix 40 (an index fund) outperformed 85% to 93% of actively managed South African unit trusts over periods of six months to five years.
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If anyone were able to find active managers who could beat the market year in, year out, it would be institutional investors, ie, pension funds and insurance firms. After all, they have teams of people to work on the problem. But the professionals put more money in passive funds and less in active than do retail investors. “We all know that on average we don’t beat the benchmark,” says a fund manager at a large Swiss bank.
The importance of costs
Expense ratios — even more than an investment’s past performance — turn out to be a strong indicator of how a mutual fund will fare down the road. “In almost every study we’ve run, expenses show up as a very significant predictor of future performance,” says Christine Benz, director of personal finance at Morningstar Inc., the investment research firm. In other words, over time, funds with lower fees are likely to outperform those with higher fees in the same category. By contrast, says Ms. Benz, “our data indicates that past performance is a weak indicator” of future results.
Last month The Daily Telegraph revealed how more than £7.3bn a year is being creamed off investors’ accounts through questionable hidden fees and charges. Millions of pension investors are falling victim to similar raids on their pension funds, as high annual management charges and other costs buried in the small print divert billions out of their nest eggs and into providers’ coffers.
But well-informed savers are voting with their feet and getting out of high-charging pension contracts. Instead, they are buying pensions at wholesale prices, and even getting paid commission normally handed to Independent Financial Advisors.