How to Beat the Investment Funds


Outrun Most Mutual Funds and Hedge Funds
while Earning a Bonus



In an effort to boost their returns from the stock market, legions of investors have turned to investment pools such as mutual funds and hedge funds. In the aggregate, however, the experience of the punters has been disappointing.

Whether the investors trade for their own account or hand over their savings to the professionals, the average payoff has a way of lagging the benchmarks of the market. The gap in performance springs from the shifty nature of the market yardsticks as well as the counterproductive moves of the participants.

On the upside, though, there is a simple way to surpass the mass of players in the stock market. In fact, the objective is not that formidable or even taxing.

The name of the game is to earn more by doing less. By turning to an index fund that uses no leverage, the wily investor can trump the competition without breaking a sweat.

Plight of Mutual Funds and Hedge Funds


Over the past decade and more, a raft of studies has shown that mutual funds as a group trail behind the stock market at large. Although the exact numbers vary somewhat from one probe to another, a representative result is that the annual return from mutual funds is on average half a percent lower than the gain from the benchmarks of the bourse.

One reason for the shortfall is that mutual funds have a habit of charging a maintenance fee based on the total value of the assets under management. In the past, the fee has ranged anywhere up to a couple of percent – and at times, even higher – of the average value of the portfolio over the course of the year.

Meanwhile, according to the usual reports, the top tier of hedge funds can produce a stream of gross profits that is comparable to the average performance of mutual funds. By contrast to the popular image, though, the turnout of hedge funds happens to be worse than the outcome for mutual funds.

Unfortunately, the usual statistics bandied about by the financial community does not take into account the distortion due to the biased nature of the cases in the database. Rather, a series of incisive studies which take the warpage into account has shown that the gross returns of hedge funds as a group are not merely measly but in fact negative.

Given this backdrop, the net return to the customers is even less for several reasons. We will note here only two of the sundry reasons for the cutdown.

A big factor lies in the performance fee, which usually ranges from 20 to 50 percent of the spoils whenever the portfolio happens to turn in a profit beyond its prior peak. Moreover, the clients have to pay a fixed charge – usually a couple of percent of the average value of the portfolio over the course of the year – for administrative expenses regardless of performance.

As a result, hedge funds in the aggregate fail to deliver the goods. The same is true of the swarm of mutual funds.

The fond hope of the operators is to beat the benchmarks of the market. Unfortunately, the actual outcome turns out to be just the opposite.

In spite of the pitfalls, a lot of investors squander their money on active funds that try to outwit the competition. The patrons could easily secure better results through cost-effective vehicles that charge a pittance for their services.

Another curio of the marketplace lies in the fact that the average investor earns even less than the average return scraped out by mutual funds. The main problem lies in the habit of giving in to alternating bouts of mania and panic.

A Winning Formula


If you were to keep up with the stock market at large, then you would be trouncing the average fund managed by professional managers. It goes without saying that you’ll also trump the mass of individual investors by a hefty margin.

In fact, you could also pay yourself a management fee of nearly half a percent a year on the total value of your portfolio. In that case, you would of course trail behind the yardsticks of the stock market by a similar amount. Even so, you could still beat the bulk of your rivals whether in the form of mutual funds, hedge funds, or lone investors.

This article will show you how to achieve this scrumptious feat.

1.  Open a Brokerage Account to Buy Stocks Online


As a savvy investor, you want to find a brokerage firm that charges you little or nothing for the privilege of handling your account. For starters, you should seek out a broker that does not burden your account with some sort of maintenance fee every year. Moreover, the brokerage house ought to charge you little or nothing when you buy or sell any type of security.

2.  Select a Suitable Yardstick for the Stock Market


What does it mean to “beat the market”? As a starting point, you ought to be specific about what you mean by the market. Your definition will determine the proper benchmark for tracking the bourse.

The best known yardstick of the stock market is the Dow Jones Industrial Average. On the other hand, this index has a number of limitations.

We will mention here just one of the drawbacks. The yardstick covers only 30 of the largest firms listed on the U.S. stock exchange. For this reason, it’s a bit far-fetched to claim that the benchmark represents the stock market as a whole.

Due to the narrow focus, the Dow is rarely the yardstick of choice for the professional community. For the same reason, the mass of researchers engaged in rigorous studies of the stock market prefer to use a benchmark which is more comprehensive.

Given this backdrop, the usual yardstick of the bourse is a broader collection of 500 stocks compiled by the Standard & Poor’s division of the McGraw Hill publishing group. The benchmark, widely known as the S&P 500 index, is the most common proxy used by professionals as well as researchers.

Since your goal is to beat the professionals at their own game, the obvious choice of yardstick is the S&P index.

3.  Select a Low-Cost Vehicle to Track the Index


Your next task is to select a vehicle whose function is to track the performance of the S&P 500 index. In pursuing its mission, the vessel should be efficient enough to require only a minuscule fee for administrative outlays.

Although there are different kinds of index funds, a good choice for your purpose is a type of rig known as an exchange traded fund (ETF). In keeping track of the S&P 500 index, the popular choice is the Standard & Poor’s Depositary Receipt (SPDR). The index fund has an expense ratio of less than 0.1% of the total value of the assets under management.

4.  Buy Some Shares of the Index Fund


The shares of an ETF may be bought and sold just like any other equity listed in the stock market. In other words, you can procure a stake in the fund within a standard brokerage account. The SPDR trades in the U.S. under the ticker symbol SPY.

The foregoing pair of labels has given rise to a couple of nicknames for the tracking fund. The security is known to its friends by the term Spiders or Spyders.

5.  Hold the Position for a Suitable Period


As an investor, your planning horizon could range anywhere from less than a year to more than a decade. If history is any guide, though, you should end up outrunning the vast majority of players in the stock market, be they full-time pros or part-time amateurs.

Moreover, you could pay yourself a nice reward of nearly half a percent each year of the value of the entire portfolio. Even after you take out the fee, your portfolio should still beat the majority of mutual funds.

In addition, you will outpace by a hefty margin the average return snagged by lonesome investors who trade for their own account. The same is true of the swarm of hedge funds, whose patrons have to settle for the leftovers after paying off the performance fees to the custodians in a profitable year; or absorbing the entire loss whenever the portfolio goes into reverse or even blows up completely.

Better yet, you don’t have to do anything to earn the windfall at the end of each year. The stewards of the index fund are obliged to take whatever steps are required to keep up with the target benchmark. An example in this vein is the adjustment of the portfolio when a flagging stock is weeded out by the compilers of the S&P 500 index, then replaced by a rising star.

In the meantime, you can go on a permanent vacation and still earn your well-deserved bonus. Moreover, a demure fund which uses no leverage is prone to survive any disaster that the market can throw at it.

In this sense, an index fund based on a robust benchmark differs from flimsy rigs in the form of individual stocks or wildcat funds. The frail instruments in the latter category can and do fall apart in large numbers.

As it happens, newborn companies in the real economy are similar to hedge funds in the financial arena in at least one crucial sense. Most of the contenders break down and go bust within a few years of their launch.

On the other hand, a market index can go on trekking forever. For this reason, a tracking fund which is managed properly should be able to do likewise.

As a result, you can avoid the near-certainty of a complete breakdown that dogs the majority of companies, along with their stocks. In a similar way, your portfolio will be much hardier compared to the mass of managed funds which have a way of going bust in droves amid the chaos of the marketplace.

Wall Street as Easy Street


To sum up, beating the bulk of the competition in the stock market can be a cinch. The trick is to earn more by doing less. By turning to an index fund that uses no leverage, you can enjoy the fruits of the bourse and limit the banes while doing nothing further to earn your keep.

You can hardly ask for more from the stock market. And you would be hard-pressed to find a similar deal in any other area of life.

Tips and Caveats


You’ll find more information on the nature of hedge funds in an article titled, “Crunch of Hedge Funds”. The review also talks about a number of related topics such as the dismal performance of the average investor. The link to the write-up is provided in the Resources section below.

You can find tips on finding an online broker in an article called, “How to Pick the Best Broker to Buy Stocks Online”. The write-up is linked below.

For most investors, the toughest part of the procedure described in this article is also the simplest one: doing nothing. The urge to meddle with the portfolio by buying and selling at the worst possible moments is the biggest reason why the majority of private investors trail behind the market averages by a sizable margin.

During the extreme stages of the market cycle, the punters load up on stocks precisely when they ought to selling, then dump their stakes exactly when they should be buying. The impact of the ditsy practice is to give up the profits and lock in the losses.

You need to control your impulses and ignore all the hoopla, whether cheery or gloomy, bubbling round the marketplace. The rewards come to those who have the grit to sit tight and ignore the madness of the crowd.

Resources


Crunch of Hedge Funds

How to Pick the Best Broker to Buy Stocks Online


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Keywords


Mutual Funds, Hedge Funds, Investment Funds, Stock Market, Investing, Index, Benchmark, ETF, Exchange Traded Fund, Fee, SPY, Strategy, Planning


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