Investing in funds like that is costly, as you pay many extra fees such as brokerage commissions, fund manager’s fees and others, which are taken out of your returns.
It is a different thing and you might don’t care that much about those fees if the fund has an excellent outcome but in the longer term the profit you will gain from such funds will be less.
For example, those fees can result to getting 70% less profit in the year 2005, for a $10,000 investment in the made in the early ‘80s. The outcome would be totally different with an index fund investment, as the fees are significantly lower.
Small number of funds gives good profits, but for how long?
Financial experts are chosen by investors while looking for someone to give them the correct guidance, under which they will gain big profits. However, the numbers show different results. Only 24 of the 355 mutual funds that existed in the ‘70s continue to gain good profits and remain in the market unaffected.
However, even profitable fund can’t provide you with the certainty of a continuous good performance as the circumstances under which funds perform well, are altering all the time. Therefore, the chances of funds performing well in the longer term may not be that high, as the fund manager might leave the fund at any time or the next manager who will succeed him, may not be that good.
Additionally, the opportunities of possible investments are different than the ones in the past and it’s really difficult for an investor to be able to know about those possibilities.
There is lack of knowledge about the reality of active managed funds
The reason why most people keep investing in actively managed funds is because they are not well informed about how costly they are. Managers tend to focus on the profits that an investor will gain, rather stressing out what the cost will be.
In a total of 200 successful funds in the latter years of the 1990s, only 198 reported higher returns than those actually earned by the investors.
Another factor that influences investors is current market trends and marketing that guide them towards getting serious decisions which are often not wise. That happened for example in the late ‘90s, when at the first half of the decade investors received great profit, whereas in the second half the stocks were overvalued, but it was too late.
Following the trends is a common tactic of actively managed funds. However, there are more smart solutions if somebody wants to invest smartly and gain profits.
The smart alternative of low-cost index funds
Index funds are a very popular solution which is also cost-efficient.
An index fund holds a diversified portfolio that reflects the financial market or a specific market sector. Instead of betting on the market, index funds hold their portfolios indefinitely, eliminating the risks of making short-term, volatile bets while simultaneously minimizing operating costs.
Because index funds track the performance of all stocks included in the index without betting on individual stocks, they’re also called passive funds.
Due to their specific way of function they don’t include any kind of operating fees whereas they offer significant profits.
Moreover, index funds are likely to outperform actively managed funds in the long-term.
Many might thing that this way of investing makes investors lose many opportunities of buying cheap stock and selling expensive ones, but in the long term the real value of the stock is leveled out/
In the long term, usually the net effect makes index funds to outperform actively managed funds, as they give profits at the real value of the stocks when at the same time the investor doesn’t have to pay for the active management costs.
How can the right index fund be chosen?
The investors should pick the cheapest index fund
Index funds include an expense ratio for management fees and operating expenses, which are usually less than one percent. However, long term they add up.
For example, the Fidelity Spartan’ Index fund annual expense ratio is 0.007 percent, whereas the J.P. Morgan’s is 0.53 percent. So they both have expenses lower than 1 percent, but over longer periods such as a decade those expenses add up.
Since index funds fluctuations follow the overall market, you should choose the fund with the lowest cost, bearing also in mind expense ratio of the company.
Take into consideration the new investing trends
New trends in index funds investment come up all the time. Already today there are 578 index funds, so it is clear that the competition is extremely high, bearing in mind that they were invented in 1975.
The older funds try to lower their expenses as much as possible and thus gain investors, whereas newer funds promise higher profits through new stock-picking procedures, in order to be more competitive. However the latter are more expensive.
For example, The New Copernicans don’t use methods, such as weighted market capitalization, but stocks are bought in proportion to the total market capitalization of each company, which means the total number of shares multiplied by the average share price. Instead, the trend could be calculating the proportions of each stock in their portfolio based on the profits of each company or what the dividends they have paid.
Keep in mind that, no matter how a fund appears to operate, it’s not easy to know which stocks are over- or undervalued, so you should prefer funds that keep a normal portfolio.
The investment trends cannot be easily predicted to be successful or not, so you should prefer keeping it low cost.
Below there are a table of cost-efficient and also a few examples of cheap index funds: