Should I outsource the investing process?

Part of the journey to financial independence is investing your savings.

But investing is, for most people, completely out of their comfort zone.

This is completely understandable. Investing comes with risk of capital loss, generally large debt if you are investing in property, and additional tax complexities.

As a result, some people may be thinking, let’s just outsource the investment process.

There are generally two ways you can outsource the investment process - investing in managed funds, or utilising a financial planner to make investment choices for you.

In theory, managed funds and having your affairs managed by a professional should be an excellent investment choice:

• You have professionals looking after your investments.
  

• Because you have professionals looking after your investments, you shouldn’t have to right?
  

• Professionals do this day in and day out, so they should be able to get better returns than the average Joe right?
  

However, history shows us that the promise of managed funds have not been kept.

In fact, some scary statistics regarding the performance of managed funds are as follows:

• The majority of fund managers do not beat the market return (in the case for Australia, the ASX200)
  

• This means that even less beat the market after their fees are taken into account.
  

• Those that do beat the market, are unlikely to consistently do so over the long-term.
  

The problem is further compounded because in good years, fund managers typically pay themselves a performance bonus.

In bad years however, they don’t return their fees (one can dream), but instead take their base fees. Even when you’re losing they are still winning.

The brutal truth of the managed fund and the financial planning industry is that their expertise, administration costs and handling fees come at a cost, and any superior returns that they can generate, are generally not enough to beat a humble index fund once their fees are accounted for. Ouch.

By way of demonstration, let’s say you had $100,000 to invest, and your financial planner decided to charge you 1% to manage your portfolio. Let's then assume that all of your money was invested into managed funds, which also charged 1% in fees to manage your money. That 2% cost, while it doesn’t sounds like much, creates a significant drag on your portfolio performance, especially over the long-term.

Let’s look at how this can play out over a number of years. In this example, we have compared two investors - an investor that put $100,000 into an index fund, returning 8% on average per year. The second investor, invested $100,000 with a financial planner, who utilised managed funds to invest. Let’s assume they also generated a 8% return before fees, which would be 6% after fees.

After ten years, the investor that put their money into a simple invest fund had an investment balance over $36,000 higher than the person utilising an investment manager. Over 20 years, that variance grows to $145,000.

And that was only with $100,000 invested. Many people are playing with much bigger amounts.

Interestingly, using this example, the investment professionals would need to consistently outperform the market by 2% every single year, just to match the returns an index fund provides.

Don’t get me wrong, financial planners can be extremely beneficial in helping you achieve your goals, but make sure the benefits they bring are more than offset by their costs. If they are just putting you into managed funds and charging fees for the privilege, it’s unlikely your returns will beat an index fund after the managed fund fees and the financial planning fees are taken into account.

The truth is, the average investor can beat the returns generated by managed funds and financial planners, by not incurring the extra costs these options entail and invest investing in a humble index fund instead.

The lessons are:

• Be aware of how much fees affect the performance of your portfolio.
  

• Be aware that history shows that the majority of managed funds and portfolio managers do not consistently outperform the market before their fees are taken into account, and even less do so once their fees are taken into account.
  

• The more fees you pay, the less wealth you will generate over the long-term. Look to reduce fees and unnecessary costs, allowing your investments to compound further.
  

• Recognise that you may need assistance, and utilising a managed fund or financial planner, is much better than doing nothing.
  

• Financial planners can bring significant value, especially if they help move you from inaction to action.