Why you're better off with a tracker fund

Fund management fees and losses due to human nature mean you're invariably better off with a tracker fund than an actively-managed fund.

If you want to succeed at investing, avoid fund managers. That's the advice of Burton Malkiel, who has spent 50 years studying the stockmarkets. "My thesis is: if you invest in a low-cost, passively managed portfolio, you will generally do a lot better than the typical high-cost, actively managed fund," Malkiel, a professor of economics at Princeton University, tells The Guardian. He has a point. Historically, tracker funds which follow an index or a market have outperformed managed funds. In the year to 19 February, the average equity-based unit trust in the UK returned 33.9%. The FTSE All-Share tracker gained 38.3%, says Patrick Collinson in The Guardian.

The difference isn't necessarily because fund managers are bad stock-pickers some of them are very good. It's a combination of factors. The biggest one is the fees for actively managed funds. Even if a fund manager delivers good returns, investors don't get the full benefit as management fees take away a large chunk. Malkiel points out that between 1988 and 2007, the average equity fund in the US earned 11.6% a year. That would be fine except that the average investor got just 4.5% a year thanks to fees.

Fees and human behaviour the other downside to managed funds. Investors both the professionals and you and I tend to pour money in at the top of the market and sell at the bottom. We'd be much better off just picking a few index funds and sticking with them. That way we limit our costs both in terms of annual management fees and the cost of buying and selling.

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Follow Malkiel's advice and investing seems simpler too. Just decide what sectors you want to invest in, then drip-feed your money into suitable index funds (or exchange-traded funds ETFs). Once a year you should rebalance your portfolio, but that's it. This method means you won't ever beat the market as you would if you were lucky enough to back a star fund manager. But nearly everything you make ends up in your own pocket.

The average total expense ratio (TER) for a tracker fund in the UK is 0.89%, and less for an ETF. But for a managed fund it almost doubles to around 1.6%. And what do you get for the extra? A good chance your manager will fail to beat the market. Managed funds in the UK All Companies sector have returned an average of 5.2% a year over the past five years, while the FTSE All-Share index has returned 6.5%. So just stick with the computer-run, cheap tracker funds.

Ruth Jackson-Kirby

Ruth Jackson-Kirby is a freelance personal finance journalist with 17 years’ experience, writing about everything from savings and credit cards to pensions, property and pet insurance. 

Ruth started her career at MoneyWeek after graduating with an MA from the University of St Andrews, and she continues to contribute regular articles to our personal finance section. After leaving MoneyWeek she went on to become deputy editor of Moneywise before becoming a freelance journalist.

Ruth writes regularly for national publications including The Sunday Times, The Times, The Mail on Sunday and Good Housekeeping among many other titles both online and offline.