Well, I know the title of this article is by all means counter-intuitive. In principle, it is usually important to research and learn well about anything that requires your investment.
But in the stock market there is an exception: Index Funds (also known as “Trackers” or “passive funds”). These funds are aimed to track the performance of a particular index, such as the FTSE 100 or S&P 500.
If you’ve just got lost in the vocabulary, let’s clarify what each word means (using very simple terms):
- Fund = a big pot of money which came from multiple investors, and is usually managed by a “fund management” company.
- Index = simply put, it is a list of the companies in Stock Exchanges, usually filtered by something like their total value.
- FTSE 100 = the list of 100 biggest companies in the London Stock Exchange
- S&P 500 = the list of 500 biggest companies listed in the New York Stock Exchange or in the NASDAQ.
So, next time you hear in the TV that FTSE 100 dropped 10% today, it means that the total value of the 100 biggest companies listed in the London Stock Exchange have dropped 10%.
Coming back to the “funds” subject, once you start to search for them, you will realize there are hundreds (if not thousands) available. Many of these are called “active funds“. “Active” because they have don’t follow a public list of of top companies, but they have “managers” moving their money as they wish, buying and selling stocks as they wish.
There are funds to invest only in certain business sectors, others only in certain companies, or countries, continents, etc. And the idea is simple: the “fund manager” creates a fancy “investment methodology”, to say that investing in companies filtered in it is more profitable than randomly select shares in the market. But, to justify all the effort on creating a fancy methodology, there is a fee that every investor has to pay, when investing in a fund. Of course the “fund manager” has great knowledge in the stock market, drive expensive cars, live on expensive penthouses, and has a team of specialists to research the market. Therefore, a fee is needed.
The fees are usually charged for each transaction (investor puts/takes money) and a maintenance yearly fee, which is a percentage of the money you have invested.
The charge differs from fund to fund but, generally, the funds that invest in riskier assets, like equities and property (real estate), will have higher year fees than their lower-risk counterparts, such as corporate bonds and gilts. And of course, fees are also dependent on how expensive are the cars driven by the fund managers…
Cars and jokes apart, the “tracker funds“, in contrast, they are “automated“. There is no decision to be taken by manager on where the money will be allocated. That decision is taken by the market itself. They make a lot of sense when you are considering to invest on the long term, and you don’t have time to research for what are the best companies to invest. As you invest in the fund, the fund will automatically (and proportionally) distribute your money to buy the stocks promised by the fund.
It might sound dull, as you would loose all the opportunities for sleepless nights (thinking what is happening on the other side of the world which might affect a particular stock you own), or all the heart racing when surfing on a exciting bull rally. Essentially, you just give the money to the fund, and wait.
In my personal opinion, I see tracker funds as a great option for lifetime savers or children account as well. Warren Buffet, one of the greatest investors of all time, goes even further. He is always giving talks about this, and mentioning how people that don’t understand stocks could easily profit from it. But in 2007, he decided to bet the theory that tracker funds are more profitable than managed active funds.
As anyone (like you and me), Warren Buffet bet 1 million dollars against a fund manager, that a tracker for the S&P 500 would be better than any other active fund chosen by his opponent, the money management firm Protégé Partners. Protégé bet it could pick five “funds of funds” that would do better than a tracker fund of S&P 500.
In summary, Buffet won the bet, as fees ate the profits of the competition. Protégé admitted defeat, but unconvincingly also declared this was just a case of Buffet having luck with optimistic markets, and in future they would win the same bet.
Obviously that previous results are not guarantees for the future, therefore it is impossible to truly know who would win. But betting on the S&P 500 performance, Buffet was actually betting that stock markets in USA would prosper. Not just the markets, but the country, generating astronomical profits for its companies.
If you are interesting in betting yours 1 million dollars in this, you might want to consider which countries (or markets) you think will prosper on the next few decades. You can choose a tracker fund with low fees, forget the matter, go enjoy life and look again in 10 or 20 years to see the result.