So you want to start investing and don’t know where to start?
This post will outline key concepts and then provide links to actually start investing…check this post regularly over the next few weeks
What is investing?
We have provided a high level outline with links to 18 one-minute videos in this post …please watch this series for a refresher on key terms and concepts.
What is active vs passive investing?
Ok, now let’s explain active vs passive investing.
Most mutual funds you see advertised are active funds. The fund manager has to think hard to come up with an investment philosophy about which parts of the market are inefficient and then a style and process of how his team pick stocks to be able to produce higher returns than the index. Of course, the team has to get paid. Marketing costs money too. And then there’s the commission to the distributor for helping to select the fund. These fees and expenses add up to a relatively high expense ratio built into the fund structure.
As an investor, you have to study 1) if these active funds can add value… 2) when they do and don’t add value. But then 3) you realise you don’t know how to pick those ‘best funds’ in advance.
Now in normal circumstances, good economic growth leads to stock market growth captured by market indices. So you can invest in an ‘index fund’ which aims to match index returns.
It’s also called ‘passive investing’ because the fund manager doesn’t have to do any research but simply buy the same stocks in the same proportion as the index. Or figure another way to get the same return. Either way, index funds aim to get the same return as the index.
How do active and passive funds invest?
When the index provider makes a change, the index fund manager needs to quickly buy the same stocks but ends up paying a little more. That means her returns will be a little less. Secondly, the index is hypothetical, so fully made of stocks, while in real life, funds have to keep a small part of the fund in cash so that they are able to meet investors’ redemption requests on a daily basis. So the index funds return tends to be mostly slightly lower than the index.
The active fund manager can hold stocks in different proportions or indeed completely different stocks to the index outside of the top 30 or 50 stocks he is compared to. He has to pick stocks based on his views on size, themes and sectors, as well as stock specific style factors such as value or growth.
The degree to which the performance of any fund has been away from the index returns over any given period is called tracking error. You would want this to be very low for index funds, and reasonably high for good active funds to get your fees worth.
Frequently asked questions (FAQs)
Now let’s turn to the most frequently asked questions we get on ETFs –
Index funds are unlisted while ETFs are listed. Index funds have to keep a bit in cash so underperform the market index while ETFs are closed-ended so don’t need to keep anything in cash, hence can track the index closer. Index funds tend to have slightly higher expense ratio than ETFs.
No, there is still some expertise required to manage index funds and ETFs to be able to closely match index returns. So yes, you need to be careful. Here is a video answer https://youtu.be/E6UVJNU4a6g
Yes, there are ETFs for all asset classes. Watch video to find out which
In short term, yes all the ETF prices would go down, but in the long term, the prices have to track the underlying asset classes. Watch video to find out why https://youtu.be/GT6QBAOejZw
Technically, can be done but watch video to find out how difficult this can be https://youtu.be/n1cus6FIEWg
Technically yes, but again, watch video to find out the challenges https://youtu.be/S9URAu2Tvko