Wednesday, November 25, 2009

How to Beat the Investment Funds: Outshine Most Mutual Funds and Hedge Funds plus Earn a Bonus

If you’re like many investors, you must think that the title of this article is just a joke, and there’s no way for you to beat the full-time pros that run mutual funds and hedge funds. Or you might expect to read here that you should go back to school and earn a graduate degree in investment finance. Or maybe you ought to go out into the financial forum and spend a couple of decades learning the trade at the feet of renowned wizards of the marketplace.

If your thoughts ran along these lines, then you were mistaken. In reality, the title shown above is dead serious. Really it is.

There is actually a simple way to outshine the mass of mutual funds and hedge funds as well as private investors. The reason is that the objective is not daunting or even demanding.

Before we get down to brass tacks, though, we ought to spell out exactly what the goal is. Also, it’s helpful to get a good grasp of the nature of the competition. That way you’ll have a better appreciation for the what, why and how of the gambit for trumping the mass of players in the arena.

Getting a Fix on Mutual Funds

A raft of studies over the decades has shown that mutual funds as a group trail behind the stock market at large. Although the specific numbers may vary somewhat from one probe to another, a representative result is that the annual return from mutual funds is on average half percent lower than the benchmarks of the bourse.

One reason 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 – or even higher – of the average value of the portfolio over the course of the year. In a hypothetical world, if the administrative load were waived, then the average fund might for the most part keep up with the market averages.

What can we infer from these observations? Based on the data, the pack of mutual funds as a whole adds no value to the task of picking stocks for investment. In spite of all their efforts to the contrary, professional managers as a group make moves that are equivalent to picking stocks at random.

Removing the Veil from Hedge Funds

In a raft of ways, the performance of hedge funds is even worse than that of mutual funds. According to impartial studies, the top tier of hedge funds ekes out a gross profit that is comparable to the average performance of mutual funds.

On the other hand, the net return to the investors is a lot less for a bunch of reasons. One big stumper lies in the practice of taking a big cut out of the profits.

The performance fee tends to range from 20 to 50 percent of the returns for any period in which the portfolio happens to turn in a profit. Due to the hefty bite, patrons end up with a significantly smaller piece of the pie.

On top of all this, the investors have to pay a fixed fee for administrative expenses regardless of performance. The usual charge comes out to a couple of percent each year of the total value of the assets under management.

Against this backdrop, the larger community of investors subscribes to a host of feckless practices. As an example, myriads of punters squander their money on mutual funds that levy a fixed fee of a couple of percent each year for holding onto their assets. The savers could easily secure better results through cost-effective pools that charge a pittance for their services.

A second curio lies in the fact that so many investors hanker after hedge funds when they could do much better on average with other vehicles including even mutual funds. Apparently the clients are unable or unwilling to ferret out the facts needed to make a cogent decision.

A third stunner involves the fact that the average investor earns even less than the average mutual fund. The crux of the problem springs from the custom of giving in to excess through alternating bouts of mania followed by panic.

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

A fourth irony is that investors as a group spend so much time and effort trying to beat the market but end up lagging the benchmarks by a hefty margin. The results could be much better if the gamesters were to take a simpler tack then ignore the market completely. In that case, the demure investors could for the most part stay abreast of the market averages without wasting any time on trading or putting up with the headache of thrashing prices.

In fact, the players could beat the market over the course of a price cycle if they were to use a technique known as dollar cost averaging. To add icing on the cake, the scheme can be set up easily then left alone to run on autopilot.

At this juncture, however, we should note that the goal of beating the market averages is a topic best left to a separate article. Getting back on track, our purpose here is to trump the average pool in the marketplace, whether in the form of a mutual fund or a hedge fund.

Paying Yourself a Bonus for Beating Your Rivals

If you can keep up with the stock market at large, then you are outpacing the average pool managed by professional caretakers. That outcome will also ensure that you beat out the mass of individual investors by a comfortable margin..

In fact, you could 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 market benchmarks by a similar amount. Even so, you would still beat the bulk of the competition in the form of mutual funds, hedge funds, and lone investors.

So what’s the best way to achieve this exceptional feat? All you need to do is to take up the following procedure.

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