Should I invest in actively managed or passively managed funds?
This is one of the most important decisions you face as an investor. Low-cost investment options like index funds and exchange traded funds (ETFs) have helped passive investing grow in popularity over the years. On the other end of the investing spectrum are actively managed funds (aka mutual funds).

So which is the way to go? Let’s look at two key areas: performance and fees.

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“Show me the money!” – Jerry Maguire

Performance 

Investing comes down to performance. This infamous quote from the movie Jerry Maguire sums it up pretty well.
A good measure of how an actively managed fund is doing is the benchmark.

So, how do actively managed funds stack up against passively managed funds?
Over the short-run actively managed fund managers had a good year last year. Over half (55 percent) beat the benchmark in 2015, found a study by S&P Dow Jones Indices.
Not bad. But when we look over the long-term, the results skew heavily in favor of index investing.

The facts speak for themselves: the vast majority of fund managers underperform the index.
Less than one in four active fund managers beat the benchmark over the last 10 years, found the same study.

To understand why most fund managers underperform the benchmark, let’s run through a simple example together.
For the most part, the markets consist of the brightest investing minds. For an actively managed fund to outperform its peers, the fund manager has to consistently beat his peers. This is often easier said than done, especially over the long-run.

A fund manager may get lucky and beat the benchmark in the short-run, but over five or 10 years, this proves very challenging. The markets are constantly changing and evolving. For a fund manager to come out ahead over 10 years, he has to continually outperform the benchmark (we haven’t even gotten to fees!). This is a tall order, especially when actively managed funds have fees weighing them down.


Fees

The facts don’t lie: Canadians pay among the highest mutual fund fees in the world. On equity mutual funds, Canadians pay an average management expense ratio (MER) of 2.42 percent, found a study by Morningstar.

I don’t have a problem with paying fees when a mutual fund outperforms the benchmark, but the problem is most don’t. So, this begs the question, are you really getting good value for your fees? In many cases, the answer is, probably not.

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For an actively managed fund to beat the benchmark, it has to beat the return of the benchmark, plus fees. For example, if the MER for ABC mutual fund is 2.5 percent and the benchmark has a stellar year and achieves an 8.5 percent return, that means ABC mutual fund has to get at least a 11 percent return (8.5 percent + 2.5 percent in fees = 11 percent), just to match the benchmark. On top of that, the fund manager has to outperform the benchmark by 2.5 percent continually over the next 10 years and beyond to come out ahead. That’s no easy task!

CRM2 to be a Game Changer

Our relaxed attitude about fees could change with the introduction of the next phase of the Client Relationship Model - Phase 2 (CRM2). As of July 15, 2016, registered firms will need to provide an annual report showing fees in dollars. This will be a real eye-opener for investors. A 2.3 percent MER may not sound high, but when you find you you’re paying, say, $575, in fees a year based on a portfolio of $25,000 for a mutual fund that underperforms the benchmark, you might think twice about investing in actively managed funds.

At Smart Money Invest, we’re all about keeping investment fees to a minimum.

The less fees you come out of your portfolio, the more money that’s working for you. We offer personalized portfolios with ridiculously low fees. Our rate of 0.45% is among the lowest in the country. Check out Smart Money Invest website today and see what you’ve been missing out on.

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