The great majority of Australian investors have or have had some level of exposure to managed funds or managed super funds due to the Australian Government Superannuation guarantee levy.
Over the past decade it has become increasingly popular to establish a self managed superfund and manage your own money. More than 450,000 Australians have established a self managed super fund in order to manage their own money.
This can be attributed not only to a desire to control their own finances but also to
the below average performance of many super funds and managed funds and a lifetime of exorbitant fees.
These fees and costs dramatically affect how much money you will have when it comes time to accessing your super in retirement. I have written a number of articles over the years that highlight independent research from groups such as Rain Maker and The Australian Institute which support this evidence.
In October 2009, I pointed to research which was conducted by The Australian Institute in my article, “Superannuation and the true cost of fees”. I referenced Dr David Ingles and Josh Fear and their research as they found that typical administrative costs of 1.35 per cent have been estimated to reduce final super fund balances by up to 27 per cent or over $130,000 for a typical worker on the average wage. This cost constitutes around one-quarter of a typical worker’s total superannuation accumulation.
Bottom line is – this is your money! And it is being eaten away by fees and charges.
If you are starting to doubt me, or think this couldn’t possibly be right, then check this out.
John Bogle, who founded Vanguard in 1974, the world’s largest Index Fund company and who has been recognised by Time magazine as being amongst the world’s Top 100 most influential people wrote a book called The little book of common sense investing in 2007.
Here are a couple of interesting findings from that book
“During the quarter century from 1980 to 2005, the return on the stock market (measured by the Standard & Poor’s 500 Index) averaged 12.5 percent per year. The average return on the average Mutual Funds (Managed Funds) averaged just 10.0 percent per year” (page 44)
“When we compare traditionally calculated fund returns with the returns actually earned by their investors over the past quarter century, it turns out that the average fund investor earned, not the 10.0 percent reported by the average fund, but 7.3 percent – an annual return fully 2.7 percentage points per year less than that of the fund” (page 51)
John Bogle’s research found that the average fund under-performs the benchmark index but fund investors do even worse.
Why ? Well, here are the answers:
The number one reason investors returns were worse off was due to people switching from one fund to the next chasing past fund performance.
In other words, people were constantly switching their capital into the fund that had the best performance in the preceding reporting period. So, they were moving their money based on past performance, and paying fees every time they made the switch, into funds that did not perform as well in the future.
The second reason was the impact of fees charged by the fund manager
Regardless of the success or profitability of the fund manager, they still charge fees. Even if a negative return (lose money) is achieved fees are charged on an assets under management model. These life long fees kill the compounded returns you would have otherwise achieved under a different fee structure.
The third reason was fund managers making mistakes attempting to time the market
That is, in the vast majority of cases they simply got it wrong when trying to pick the bottom to buy, or the top to sell.
Fund managers have been backed into a corner as they try to chase performance. With millions and sometimes billions of dollars under management, the fund manager is tasked with trying to out-perform the index. This is near impossible as the manager is driven to trade only the liquid stocks with large amounts of capital. These same liquid stocks make up the market so the Fund manager tries to time the market and invent strategies and processes to beat it. Quite simply the research proves that fund managers make mistakes trying to out-perform the market and on average, achieve the opposite.
Financial Planners or Investment Managers
This is an industry that has exploded over the past two decades as a result of the introduction of compulsory superannuation, and an ageing population seeking advice on what to do with both their investment and retirement funds.
There are two types of financial planners:
- Those who charge a Fee for their service
These financial planners will charge you an upfront fee to provide you with a financial plan specific to your situation. This will be a personalised financial plan for which you pay the financial planner a prescribed fee, with no ongoing hidden costs or fees. It is said that approximately 5% of financial planners operate under this model.
- Those who charge trail based fees on funds under management
These financial planners do not charge you a direct fee for their service. Instead, they receive a fee from the fund managers and other product providers that they advise you to invest in. These fees are more often than not ‘trailing fees’ – while your money is invested in the product the adviser or planner receives an annual fee for no real ongoing work.
A funds under management (FUM) model can become very costly for investors as the fees continue to be paid to the asset manager on a annual basis. Under this model the planner is challenged to remain objective and act in the best interests for the client. There is undoubtedly a temptation to place clients funds in the products that generate the highest fees for the financial planner, rather than those that deliver the highest returns to the client. It is said that approximately 95% of financial planners operate under this model but government legislation is slowly leading to change.
What does this mean for you as an investor?
Making a decision to manage your own money should not be made lightly. But the alternatives of a hand off approach and instead leaving your super or retirement nest-egg to others to manage is a problem that requires a solution.
In the end it’s your money and the decisions you make today will affect you directly and probably in a big way many years down the track.