On the other hand, some people do it all by themselves, apart from a discount broker with some mixing up of their exposure to shares and funds. But for many investors the burning issue remains — should I create my own portfolio or rely on an expert fund manager to make the decisions on what shares to buy and sell.
A viewer of my program on Sky News Business Channel — SWITZER — actually sent me this question: “If I owned a $100,000-share portfolio and it rises 10 per cent, the gain is clearly $10,000. If the same share portfolio was held in a managed fund, how much of the gain would be passed on to my account?”
This could have been a loaded question, but it also could have been one as consequence of a bad outcome with a fund. The answer to this isn’t a set one as fees differ per fund, but let me have a crack at it to open people’s eyes to working with a fund.
In both cases, direct shares and managed funds, the portfolio would rise by 10 per cent. This is based on the portfolios being exactly the same and assuming the rise comes about from capital gains only (no sales are made or income received so tax does not come into play, and this is important).
However, managed funds charge a fee for the service they provide. In our example, a difference in the net return will occur due to the management fee. This is calculated daily and reflected in the unit price of the fund that is published daily in most cases.
The management fee, also known as the management expenses ratio, is the fee that represents the costs of running the fund plus the extra fee paid to the fund manager for their expertise. The fee differs between funds, and in 99 per cent of funds, the fee is percentage based. The fees are published and are available for each managed fund. Note, good financial advisers wish fund managers would charge a flat dollar management fee - this would represent a real and tangible saving in fees and charges for investors.
Just to clarify the unit price of the fund in simple terms, it’s the market value of the fund less expenses plus income and then divided by the number of units on issue.
So, managed funds are a trust with all unit holders owning their own individual share of the investments and they share the costs of running the trust.
Know your expenses
By the way, there is also a buy/sell spread fee with funds for getting in or getting out of a fund. This averages around 0.2 per cent but it can be as high as 0.7 per cent.
So to answer the question, if the total expenses were two per cent, then the return would be 10 per cent minus eight per cent. That means when you compare fund performances you have to make sure they are net of expenses. And you must always know all of the expenses that come with a managed fund.
There is another issue with funds. Sometimes a fund manager sells shares to pocket capital gain to improve their annual returns so they compare well on performance tables. This can deliver unit holders (investors) a big surprise called a capital gains tax bill!
Kitchen renovation analogy
So why would you invest in a managed fund. This is a highly charged question but I loved the answer my colleague at Switzer Financial Services, financial planner, Peter Small came up with. The answer can be found, he said, if we think about the process of renovating a kitchen.
A kitchen renovation can cost from very little to a small fortune. The way to keep costs down when renovating is to do a lot of the work yourself and to possibly buy fittings and fixtures of a lesser quality. So a home renovator can waste countless hours pulling out cupboards and knocking holes in walls only to then discover that they are in way over their head.
Investing is the same. You can do it yourself and keep your costs down to say the cost of buying a newspaper for research, a computer, a broadband connection and don't forget brokerage costs for buying shares.
On the other hand, you can employ someone to do this for you. You can go the whole hog and employ a share broker to trade on your behalf, that is give them a chuck of money and off they go.
Another way to outsource your investing is to invest in a managed fund and let the fund manager worry about securing the shares, working out and reporting to you the capital gains and income for you and when to buy and sell investments. Managed funds are just about getting the kitchen guy or girl to renovate the kitchen for you.
Bill Moss of Macquarie Bank fame agrees with this argument and says if the fund manager can outperform you, then the fees could be of little consequence.
Index fund versus fund manager
Recently APRA made the point that the average investor would be better off with an index fund rather than using an average active fund manager. However, fund managers say why compare to an average fund manager? They say look for an above-average fund manager.
That is easier said than done and that can be the value of an honest financial adviser who knows what funds are hot and the ones that are not. Also when you go it alone, you can end up with a portfolio that needs rebalancing and this happens when share prices go up and down.
It does get down to your expertise, your free time and your inclination to turn yourself into your own fund manager. Know what your costs are, go looking for the best and do your homework, and you should make the best out of this buying opportunity of a lifetime.
Important information:This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice.
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