Ever since the whole Lehman Brothers debacle in ’08, there’s been a lot of suspicion regarding funds. In truth, Singapore’s tightly regulated finance sector makes it difficult for anyone to scam you (unless you choose to dabble in unregulated products, in which case no one can help). Still, here are some of the common traps to look for:
1. Hidden management fees
Ah, you’re savvy enough to know about fees! Congratulations. But that’s why many a sales brochure now advertises “low management fees”.
Now ignore the management fees, and look for the Total Expense Ratio (TER) or Annual Expense Ratio (AER). Because that’s probably where you’re going to see the real cost. The management fee is just one type of fee that goes into running a fund: there are also marketing costs, staffing costs, legal consultations, etc.
Many savvy marketers know that new investors have been taught to look for “management fees”. As such, some funds have begun to advertise low management fees, while padding the costs elsewhere.
2. They gloss over their fees
Some funds will say that: “Our fees only cost one percent, but our returns are five percent!”
That’s not the point. The point is that the returns – after fees – are four per cent instead of five per cent. That’s a twenty percent drop in returns!
A one per cent difference in investing is a big deal — if the investment horizon (the time you remain invested) is long. For example, if you invest $2,000 a month for 30 years, at five per cent per annum, you will end up with over $1.66 million. At just one per cent lower, the result is around $1.39 million. That’s not chump change.
If you want to know how to invest yourself, without forking over tons of cash for fees, check out some of our courses.
3. The fees are much higher because the fund is managed by “top” professionals
As a new investor, you have no way of identifying who a top professional is. An untrained investor cannot accurately evaluate the worth of a fund manager, any more than we in this office could evaluate the skills of a Swedish cheesemaker.
Even among experts in the finance industry, it’s debatable if a fund manager can be accurately assessed. We sometimes can’t tell if the fund manager is inept but happened to get lucky, or highly skilled but got into a run of bad luck. So overall, this is not a good reason to pay a lot more.
4. They only highlight exceptional returns during one period
It’s great that the fund performed well that one time eight years ago during the Global Financial Crisis. But don’t look at specific “episodes” with which to gauge the fund. It’s better to look at returns over a long period (say 10 or 20 years) to determine overall performance.
It’s entirely possible that the highlighted episode is a fluke. For example, a fund may have consistently weak returns, due to its risky decision to always bet against the crowd (oversimplified contrarian investing). But it got lucky in 2008 just because it bet against the mortgage-backed securities which caused the collapse.
5. This fund contains AAA-rated assets, so it’s “super safe”
Almost everyone selling a proper, regulated product is probably holding a fund that contains some investment-grade assets. But you can still lose money on a poorly managed mutual fund, even with its safe assets.
Remember that those credit ratings are for the assets in the fund, not for the fund itself. For example, a fund may own Temasek bonds, but Temasek’s AAA rating doesn’t also mean the fund is as creditworthy as Temasek.