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How can that be? For one, speculating on stock prices is simply not a sustainable strategy.
Add that pitfall to the high costs of the funds, and the result is that an actively managed fund will generate significantly less profit for you than a passive, low-cost index fund that merely mimics the performance of the overall market.
Before you do, though, consider if those funds perform well compared to the overall stock market. Most funds go bankrupt or fail to generate significant returns. Investors pay huge fees to funds, deferring to financial experts who have a solid understanding of the stock market. However, despite industry knowledge or expertise, only 24 of the mutual funds that existed in have outperformed the market consistently and remain in business.
You might decide to invest your money in the funds still outperforming the market consistently; those funds that have beaten the odds. However, even if you analyze their track record, the same conditions that caused the fund to perform well over the past 35 years may not repeat themselves in the following decades.
For example, if a fund consistently outperformed the market in the last 35 years, the fund manager probably played a huge role in its success. But, the manager will inevitably retire at some point. How do you know the next one will have a similar rate of success? Also, future investment opportunities will differ from the ones of the past 35 years.
How do you know the possibilities for future investments? First of all, investors often underestimate the true cost of actively managed funds.
However, fund managers rarely disclose the dollar amount. Instead, they boast about the high returns but forget to divulge what the investor will really earn after deducting all the performance and portfolio fees. Surprisingly, that omission occurs often: of the most successful funds in the latter years of the s reported higher returns than the investors actually earned!
Secondly, in many avenues of investing, people often tend to let their emotions and current market trends make important decisions for them. All too often, people make unsound investments because they let popular opinion and clever marketing sway their decisions.
For example, recall the high-risk investments of the late s. When the bubble eventually burst, people realized too late that they had given into the popular hype. This same principle applies to actively managed funds: investors pour money into these funds because everyone else is doing the same thing.
The index fund is your best alternative. In contrast to actively managed funds, index funds are much more cost-efficient. By definition, an index fund holds a diversified portfolio that reflects the financial market or a specific market sector.
However, instead of betting on the market, index funds hold their portfolios indefinitely, eliminating the risks of making short-term, volatile bets while simultaneously minimizing operating costs.
Since they simply hold shares across particular market sectors, you will not have to bear operating fees for downloading and selling shares, financial consultants, or fund management. You will, however, reap the benefits of commercial net returns.
However, you already learned that in the long term, the rises and falls of the stock market eventually level out at the real value of the stock. Because of that net effect, index funds usually outperform actively managed funds in the long run; they offer returns at the real value of the stocks while eliminating active management costs. Money flows into most funds after good performance, and goes out when bad performance follows.
Fund returns are devastated by costs, taxes, and inflation. The winning formula for success in investing is owning the entire stock market through an index fund, and then doing nothing.
Just stay the course. The Little Book Of Common Sense Investing Chapter 7: Unless the fund industry begins to change, the typical actively managed fund appears to be a singularly unfortunate investment choice. The Little Book Of Common Sense Investing Chapter 8: Funds with long-serving portfolio managers and records of consistent excellence are the exception rather than the rule in the mutual fund industry.
To build a well-diversified portfolio, you might stash 70 percent of your stock portfolio into a Dow Jones Wilshire index fund and the remaining 30 percent in an international-index fund.
The Little Book Of Common Sense Investing Chapter 9: In selecting mutual funds, most fund investors seem to rely, not on sustained performance over the long term, but on exciting performance over the short term. With each passing year, the reality is increasingly clear.
Fund returns seem to be random. Under normal circumstances, it takes between 20 and years [of monitoring performance] to statistically prove that a money manager is skillful, not lucky. Indexing wins hands-down.
All index funds are not created equal. It should be your own cash cow.
This differential is largely due to fees. These still involve nearly as much risk as concentrating on individual stockpicks. The majority of investors should be satisfied with the reasonably good return obtainable from a defensive portfolio. The real money in investment will be made not out of downloading and selling but of owning and holding securities. The Little Book Of Common Sense Investing Chapter The two sources of the superior returns of the index fund: 1 the broadest possible diversification; and 2 the tiniest possible costs.