Saturday, March 03, 2007
If you think education is expensive - try ignorance
The key to successful investing and achieving high interest rates of return is to educate yourself. It's a trite saying, but true: No-one will take care of your money as well as you will. If you feel you lack the confidence and knowledge to manage your own investments - try a trip to the finance section of your local bookstore. It's likely to be much cheaper than engaging the services of a professional financial planner.
Financial literacy is a major problem in this country. How do I know this?
It must be when even the government wants something done about it! :-)
You've probably received in your mailbox recently a free booklet from the Australian Government entitled Understanding Money.
The booklet is published by the newly founded Financial Literacy Foundation. Here's an excerpt from their web site:
The Financial Literacy Foundation is chaired by well-known Money man, Paul Clitheroe.
Who we are
The Financial Literacy Foundation has been established by the Australian Government to give all Australians the opportunity to better manage their money. The Foundation was launched on 6 June 2005.
What we do
The Foundation provides a national focus for financial literacy issues and works in partnership with government, industry and community organisations to advance financial literacy in Australia.
We are raising community awareness of financial literacy and its benefits through the Understanding Money media campaign.
The campaign aims to kick start change in attitudes to money issues and ultimately, equip people to ask the right questions and make better financial choices.
While I applaud the governments attempts to raise the financial literacy of the average Aussie, I do find it a little bit disheartening that Mr Clitheroe is such a great advocate of giving up on the whole idea of managing your own investments, and instead turning your money over to someone else to look after.
Some words of wisdom from Mr Clitheroe: Let funds do hard stuff
If I were a cynical person, I might suggest that as the "director of [a] financial planning firm", Mr Clitheroe might have a vested interest in encouraging investors to hand over their funds to "professionals" - even when those professionals "don't always do better than the [sharemarket] index".
AUSTRALIANS are among the world’s keenest sharemarket investors, but if you’re unsure about investing in shares directly, a managed share fund is a good option.
Managed share funds work by pooling the money of like-minded unit holders, and investing these funds in the sharemarket.
This gives ordinary investors access to the stockmarket with none of the traditional concerns about which particular shares to buy, and when to buy and sell them.
In return for this convenience, the fund manager charges a fee, known as the MER, or management expense ratio, based on a percentage of the amount you have invested.
There are basically two types of share funds: index funds and actively managed funds.
It’s worth knowing the difference as they involve separate approaches and charge quite different fees.
Index funds, also known as passively managed funds, seek to match the investment performance of a given sharemarket index, such as the Standard & Poor’s-ASX 200 (measuring the performance of our top 200 listed companies).
Instead of trying to beat the market by actively trading shares, the index fund manager simply holds all, or a representative sample, of the shares in the same proportions that they appear in the index.
This doesn’t lessen the risk of investing in the underlying asset class, it merely ensures that your returns (both good and bad) will not stray far from the index that the fund mirrors.
Index funds are far cheaper to manage than actively managed funds, and for unit holders this means lower fees.
Some index funds charge zero entry and exit fees, and as little as 0.5 per cent in annual MERs.
Most investors want to beat the market rather than simply keep pace with it and that’s what an actively managed fund aims to do — look for shares that may offer good capital growth or companies that have strong prospects of doing well over time.
As this involves active research, expertise and a lot more work on the part of the fund manager, these funds involve higher MERs, sometimes as much as 2.5 per cent annually.
Unfortunately, outperforming the sharemarket is more difficult to do than you might think — especially over the long term.
There are two main reasons why professional fund managers don’t always do better than the index.
The first is that it’s almost impossible to consistently pick winning investments.
Without the benefit of a crystal ball it’s inevitable that you will chase some losers.
Secondly, regular turnover of shares involves additional costs including brokerage, reducing the bottom line.
One possible strategy is to hold a core amount with an index fund, and have the remainder of your share portfolio invested across a number of actively managed funds, each focusing on a particular area of the sharemarket.
- Paul Clitheroe is a founding director of financial planning firm ipac, chairman of the Financial Literacy Foundation and chief commentator for Money magazine.
Of course, I would never make such a contemptuous suggestion. :-)