Investors everywhere are waking up to the idea that low-cost really is best when it comes to investing, provided you are still getting strong performance. There is no point in achieving 3% per year if you pay 2% in fees, reducing that fee level has a very real impact on your wealth.
Even when you have realised that low-cost really is best you are still faced with multiple options. There are ‘low-cost’ mutual funds, exchange-traded funds (ETFs) and to access these you need an investment platform and there you can choose between a broker or a robo advisor or digital wealth manager.
Why do people love mutual funds?
Mutual funds have been around for almost a century but it was not until the 1990s where they really took off. A mutual fund works through a group of investors pooling their money together, a professional manager then invests that in a diverse set of securities and returns (gains or losses) are shared between the investors. It is a cycle.
For decades mutual funds really were the only way to invest as ETFs were not well developed. But now mutual funds are the ETFs more expensive older brother and more expensive does not necessarily translate to better performance.
As with any instrument, not all mutual funds were created equal, there are passive and active mutual funds available at a low-cost to retail investors. The high fees come from the more traditional active funds.
Why consider an ETF?
The ETF offers more diversification than a mutual fund. You can buy a single ETF and own a whole market, you can buy another and own thousands of stocks from around the world. It sounds so simple but as the ETF market has grown many ‘bad’ ETFs have appeared so you have to pick your ETFs carefully looking at liquidity, exposure and a number of other instruments.
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The other challenge with ETFs is that it is simple to own an ETF but it is also very easy to slip into inactivity. If you take the recent referendum result as an example, equity was going up as we drew closer to the vote and the market priced-in the likelihood of remain, the vote to leave shocked the markets and led to a sell off. In a little over a week you will have seen the value of your investment go up, plummet down and then return to pre-BREXIT levels.
Welcome the robo advisor
This is where a robo advisor company like Moneyfarm comes in. You open an account in a few minutes, answer a survey to define you investor profile and receive a portfolio that suits your need. Diversification is absolutely key when investing (read more on diversification) as asset classes fluctuate at different times.
At Moneyfarm we set a long-term target for risk as well as a short-term target. This means that you will have a portfolio that is designed to your risk tolerance so you should be comfortable with the movements and work towards long-term wealth appreciation.
What to choose?
When making your decision you really have to weigh up the cost as this impacts the real performance and your overall wealth. The first question you should ask is do you believe active can outperform passive enough to justify the fees? If no, then you should also ask yourself do you have the time and knowledge to effectively manage your portfolio yourself?
Not many people do have the time but the dawn of the robo advisor has meant you do not have to pay a huge amount for this either. Whichever route you decide to go down you should make your decision quickly, because the one thing history has shown us is the longer you are in the market the better.