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The tortoise and the hare
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I saw this article “Non-profit super shows best returns” today which reported that between 2000 to 2009, funds operated by unions and employers on behalf of members posted the best annual returns. Retail funds – those run for profit by financial institutions – were nowhere to be seen on the league table, which ranked a typical ”balanced” fund with money spread across different asset classes. I guess the outperformance of “industry” vs “retail” funds does not come as a surprise to many of us but I never realised how much of a difference fees made to returns until I did my own comparisons today.
Reading the article reminded me of that I still had some money in a retail fund which I bought ages ago. Due to some restrictions in the product I bought, I could not roll over the funds into my SMSF without a big penalty so I left decided to leave it as is. When we expected a market correction in December 2007, we converted investments in our SMSF to cash but forgot to do the same for our retail funds. My AMP Balanced Growth Fund had been showing average returns of -13% in the past two statements and I was hopeful that some of the losses would have been recouped in the recent market rally. It had recovered some, but it was still 22% less than what I had in the fund in Sept 2007. As I am expecting another stock market correction in 2010, I wanted to switch to a more conservative fund. The customer service person gave me a couple of alternative funds I could switch to – AMP Conservative or AMP Fixed Interest. I was very surprised by what I found when I compared the three funds. Morningstar provided a very simple way to compare four year returns in each fund by showing what you should have in your account on 31 Dec 2009 if you invested $10,000 in each fund on 1 Jan 2006 and the results were:
- AMP Balanced Growth – around $10,500
- AMP Conservative – around $10,850
- AMP Fixed Interest – around $11,300
The boring fixed interest fund out outperformed the others even though the average annual return was only 3-4%. The other funds had returns ranging from +16% in a good year to -16% in a bad year. You may ask, how can a fund with such low returns outperform funds which can have double digit returns in a good year? The secret is not to lose money at all every year. The more money you lose, the harder it is for you to get back to even again. If you lose 50% of your capital, you will need to make 100% just to get back to even. If you lose 20%, you will need to make 25% to break even. However, if you consistently make 3% each year, this will be compounded as the 3% will be on a bigger amount the next year. Another advantage of the fixed interest fund is the lack of volatility. It sure is not fun to watch your retirement fund drop by 16% in a year. It is much nicer to see a growing nest egg even though the pace of growth may be slow.
After comparing my options, I decide to move my money to the AMP Fixed Interest fund. I figured another advantage of this fund would be lower management fees. I was shocked again by what I found when I compared the management fees of the three funds. The management fee was exactly the same for all three funds at 1.32% p.a. How many highly paid MBAs do we need to run a fund that is 100% in cash? I would expect to pay 1.32% for a fund that is actively managed which generates returns of 10% or more. But 1.32% for a fixed interest fund is daylight robbery, especially when compared to Hostplus which only charges a fee of 0.01% p.a. for their Cash fund! No wonder the average annual return for the Hostplus Cash fund was 5-6% vs 3-4% for AMP. If you apply a compounding 5.5% annual return on $10,000, you should have $12,388 after 4 years, which is far more than the above three funds. Imagine the difference after 10, 20 or 30 years!
In summary, I have learned two lessons today:
- Just like the tortoise and the hare, consistent small positive returns can outperform high but volatile returns in the long run.
- Fees can vary widely between funds and it can make a big difference to your returns over time
If you still have money in a retail fund, it will pay to check out your other options.
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[...] if I achieve -15% for that year, even though I have outperformed my benchmark. I would prefer a small positive or even zero return compared to losing money. However, this is only possible if your SMSF is not constrained to having a [...]