Choose funds with the lowest fees

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You have followed the suggestions in the book Millionaires are from a different Planet! when investing in unit trusts. You have narrowed down the funds to those that meet your desired objective, has good management, a good track record, excellent service and low cost of operation. But there's still five funds that meet all these criteria. So which one shall you choose? How do you decide which fund that will get the privilege of doing business with you.

Man oh man, have you logged on to the right site today, because the answer is looking straight at you.

Performance is linked to low cost

Of course, the acid test in investing is performance. The better performing funds (those with higher returns) will be the best bet for you to invest your money.

Having stated this, I must also add that interestingly, the record has shown that the better performing funds tend to be those with low cost of operations, namely the no-loads funds.

In fact, in the US, the no-load index linked funds has outperformed 80% of actively managed funds throughout the years. For all the brilliance, for all the knowledge and experience of the fund managers, they are often outperformed by the passively managed no-load index linked funds.

Why is this so?

Funds that are actively managed have higher fees than those without. This is because the management company has to pay the salary of the fund manager, cost of research and commission for the agents, among others.

On the other hand, no-load index linked funds do not have to bear this heavy burden. They do not have to pay commission to the agent, research cost or even the salary of the fund manager, and can therefore charge lower fees.

Now comes the interesting part.

For all the ups and downs, for all the lows and highs, the performance of MOST of the funds tends to be about the same after a period of time. Returns above or below long-term norms tend to move down, or up, towards the norm. This effect is known as regression towards the mean.

What all this means is that, most of the funds will give similar returns after some years. (For a more detailed explanation about this, you may want to check out the book Bogle on Mutual Funds written by John C. Bogle, former chairman of the Vanguard Group of investment companies, with assets totaling over US100 billion).

Now, I realize that this may be a surprise or even a shocker for many of you. The funds will give similar returns? It may be hard to believe but some things are true whether you believe it or not. And the track record has shown that this is the case here.

So if most of the funds will perform about the same, what will make the difference then? The obvious answer is of course, the cost of operations. The funds with the lower costs will dash ahead of the pack. This is the main reason why they outperformed 80% of the actively managed funds.

Where has all the fund managers gone to?

No doubt there are fund managers that will outperform the others. But the problem is who? How can we identify the stars out there? I for one, don't know of a single fund manager in Malaysia that stand head and shoulders above the rest.

Even in the US, there are but a handful of superstar fund managers. The last great one was Peter Lynch who ran the Fidelity Magellan fund some years back. (Too late - he has retired).

While any fund manager can outperform the market for one, two or even three years, it would be asking too much to ask him to do it year in year out for ten, twenty years. In fact, it would be impossible. No one can do it.

Win the war and not the battle

This being case, we would be well advised to invest in funds with low entry cost (no-load or sales charge) and with low management fees. While these funds may lose out one or two years, but they will come out ahead in the long run and outperform most of the actively managed funds.

After all, we are concerned with winning the war and not each and every battle.

For a more comprehensive explanation, please read my Handbook entitled Unit Trust Investment (versi Bahasa Melayu berjudul Pelaburan Unit Amanah).This 28 pages Handbook is an essential reference for everyone considering investing in unit trust. Includes detailed information on NAV, bonus and how to choose a fund.

 

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