Can your financial adviser beat par?

 

Many active fund managers, as well as the financial advisers who recommend their costly funds, like to tell us that investing in low-cost index funds is “settling for average”. This can be an effective marketing ploy – after all, who wants to settle for average investment returns?

So let’s make one thing very clear – long-term investors in index funds do not get average returns, they get really good returns. In fact, they get far better returns than the average investor, returns that are extremely difficult to match with active funds.

The first index fund was launched in 1976. One of the lawyers involved in setting up the fund invested $15,000 on day 1. In 2006, a dinner was held to celebrate the 30th anniversary (by the way, very few active funds actually last 30 years – most are closed down or merged into other funds). At that dinner, the lawyer stood up and told the room that the $15,000 was still invested – its value that day – $461,771. Now there’s a number that speaks for itself.

Famed investment writer Burton Malkiel – a professor of economics at Princeton University – perhaps put it best when he said “Many people will find the guarantee of playing the stockmarket game at par every round a very attractive one.”

There are two key words there – “guarantee” and “par”.

Index funds guarantee you receive your fair share of the total market return (which – for reasons I’ll go into in another blog post – is far better than the return of the average company).

“Par” is a term used in golf to describe the number of shots an expert golfer is expected to take to complete all the holes on a golf course. “Breaking par” consistently is extremely difficult, even for the very best golfers. It is therefore a mistake to think of par as “average”. From 2012 to 2016, the best performer at the men’s US Open tournament was Dustin Johnson, with total earnings of around $3 million. If “Mr Par” was a competitor, he would have earned nearly $4 million. If Mr Par existed, he might just be the best golfer in the world. He would certainly be the most consistent.

Sure, some pro golfers often break par in a round. Sometimes they do it three or four rounds in a row and win tournaments like the US Open. There is, however, no way of knowing in advance in which rounds, or which tournaments, they will do it. Similarly, there is no way to predict which active fund managers will beat an index fund in a particular time period. What we know for sure is that it can be very expensive to try – active funds usually cost many multiples what index funds cost. What’s more, it’s far more likely you will be wrong than right. Thankfully, it’s a game you don’t need to play.

If you like gambling, have a small flutter every now and again on a golf tournament or a horse race. Don’t gamble with your life savings.

 

Phil Miller – Head of Client Services, Marland Thomas Solicitors
08 December 2017

The information in this article is necessarily of a general nature. It does not represent either legal advice or financial advice. Specific advice should be sought for specific situations.