Is it worth paying for a fund manager?

Not a fan of fund managers

Fund management is an enormous industry making fortunes for those privileged people in the fund management role. The following article questions whether these people are worth the money:

In short, "no"! I don't believe that it is worth paying for a fund manager and in this article I outline my reasons.

What can you expect from the stockmarket?

Historically major equity indexes have grown at an average rate of about 5% - 7% over the long term (think decades!). Let us assume that you have £10,000 to invest. If you bought units in a passive fund that simply tracks the equity index (also called an index tracker) at 7% average return you can expect to double your money every decade. However we must also take into account the charges. On an index fund this will normally be a charge of about 0.5% annually. Rather than having £20,000 in ten years time you would have ended up wth £18,900 - not bad. 

What can I expect from an active fund?

An active fund is one that is run by a fund manager. Given that you have a fund manager who's full time job it is to invest and grow the size of the fund, naturally you can expect to pay more to be invested in the fund.

An active fund with a fund manager in charge will cost you anywhere between 2% - 5% in annual management charges. As a result, in order to make the actively managed fund a more attractive prospect the fund manager would have to beat the growth on the index fund to justify their wages.

Fund management example:

Let us imagine that at worst your fund manager is able to match the index and as a result achieves 7% per annum over the next decade. Let us also assume that the management fee is only 2% per annum. This means that after ten years your investment would only be worth £16,000 - you are worse off paying for the fund manager.

In order for the fund manager to justify their charges they would need to achieve a return of  at least 8.5% in order to beat the market and provide you with at least as good a return as if you had invested in an index fund. Indeed, I would argue that if you are going out of your way to use a fund manager then they would need to achieve at least 9% per annum in orde to justify their fees. The situation is even worse if the fees are higher.

So, how many of these fund managers beat the market index? Unfortunately, it is estimated that only 20%-30% actually beat the market. In addition, remember that due to their fees not only do fund managers have to beat the market they must beat it by at least 1.5% or more in order that you make a better return than had you simply invested in a passive index fund that tracks the market.

You don't like my argument against fund managers?

It is possible to query my numbers and argue which numbers are accurate and which are not. However, the illustration still stands. The point is that in order to justify their fees the fund manager has to be significantly better than average and to do this consistently over the long period. There aren't many fund managers out there that could achieve such a feat. Furthermore, the odds of you happening to find such a fund manager are even less likely. Picking a good fund manager is just as hard if not harder than picking good investments!

My advice: steer clear of the actively managed funds. Don't pay extra for the small chance of beating the market. Instead, track an index fund - that way you are the market!

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