Paying a fund manager to seek out the best investments for you may seem like a sensible decision.
But as star manager Neil Woodford has showed us, these often idolised investment experts are only human and can make colossal errors in judgment.
Just two weeks ago, Mr Woodford was forced to bar savers in his Equity Income Fund from accessing their money after investors rushed to make withdrawals following two years of poor performance.
As star manager Neil Woodford has showed us, these often idolised investment experts are only human and can make colossal errors in judgment
Now experts are warning that your savings may do better sitting in a so-called tracker fund.
These are already very popular among investors, accounting for more than eight in ten new investments into funds in April.
Also known as passive funds, trackers aim to replicate the performance of a specific index, such as the FTSE All-Share Index.
When the index goes up, so does the return on your investment. But if the index goes down, the value of your investment will fall.
By comparison, active funds try to outperform the market and are run by managers — such as Mr Woodford — who buy and sell stocks based on their research.
They scour company reports and accounts, meet with the management, competitors and suppliers of the firm, and track wider political and economical changes that could affect your investment.
However, if they are wrong and the stocks they choose fall in value, so, too, will the value of your savings.
With tracker funds, when the specific index goes up, so does the return on your investment. But if the index goes down, the value of your investment will fall
Active funds are also far more expensive than trackers. So even if the fund does perform better, the bigger fees could eat into those returns.
Iain Barnes, head of portfolio management at Netwealth Investments, a wealth adviser, says: ‘Managers tend to be guilty of chasing the next big theme regardless of whether they can outperform the market.
‘There is a chance you could get a bigger return, but only if the strategy works. Right now, Terry Smith [chief investment officer of Fundsmith] is doing really well, for example. But the odds are stacked against managers.’
He adds that investors’ best chance of growing long-term returns after fees are taken into account is to build a diverse portfolio of passive funds.
In April, trackers made up 83 per cent of all new investment into funds — an almost 23 per cent increase compared with the previous year, according to a report by trade body The Investment Association.
The attraction of trackers is their ability to grow modest but stable returns over the long term without requiring you to have any in-depth investment knowledge.
If you had invested £10,000 in the Vanguard FTSE UK All- Share Index tracker five years ago, for example, you would have £12,912 taking into account an annual fee of 0.08 per cent.
Or, if you had invested in the L&G UK Index Trust, which tracks the same index, you would now have £12,875, after annual fees of 0.1 per cent were deducted.
Successful active funds can outperform their comparative index for a period of time, earning investors a much better return on their money.
The SDL UK Buffettology fund, for example, would have turned a £10,000 investment into £20,806 over five years after annual fees of 1.73 per cent.
The Lindsell Train UK Equity fund would have turned £10,000 into £18,219, after fees of 0.68 per cent.
But many funds fail to beat the market. Over the past five years, 61 per cent of active funds underperformed the market, according to analysis of Financial Express data by wealth advisers AJ Bell.
In April, trackers made up 83 per cent of all new investment into funds — an almost 23% increase compared with the previous year, according to The Investment Association
Ryan Hughes, head of active portfolios at AJ Bell, says: ‘Most fund managers are not very good at what they do and under- perform the index over time.
‘There are skilful managers, but as an investor, you have to understand what they are doing, and know when their investment strategy is no longer going to deliver a return.’
M eanwhile, as investors withdrew £46.8 billion from UK active funds in the 12 months to the end of May, they ploughed £10.8 billion into trackers, according to financial data firm Morningstar.
Active funds cost a lot more to invest in than trackers because a fund manager is buying and selling stocks in companies on your behalf.
The average annual fee for UK equity active funds is 0.86 per cent compared to 0.28 per cent for FTSE All-Share Tracker funds.
Despite paying more for your fund to be actively managed, investors still have to do their own active management or risk suffering losses. Investors need to monitor the fund’s performance, the companies it holds and make sure the fund manager is behaving as they should.
However, Mr Hughes says that while Mr Woodford’s issues may have spooked investors, active funds still have a place in investing. ‘It is important not to throw the baby out with the bath water,’ he says.
‘There are good firms out there, such as Troy Trojan Income and Man GLG Undervalued Assets, but they are hard to find.