Tuesday, January 19, 2010

Strategies for the successful investor part 5 :Do not trust experts or fund managers

The one thing that most people think is that they can outsmart the market and have a better return than the overall return of the market. What can happen is that a few person can outperform the market for a few years but over the long run they would most likely either underperform the market or come close to it.

On the long run the best you can do is to equate the average return of the market. Thus the only investment that would come close to the market average rerun would be the index fund or a mutual fund that is invested in a broad range of stocks and bonds.

why is it that no one can outperform the market?

1. Most fund make use of researches and fund managers that are highly paid so that their salaries have to be deducted from the return of the fund. This would thus reduce the fund’s overall return.

2. A lot of these actively managed funds rely on selling and buying of shares so that investors in these funds need to pay capital gains tax. These taxes thus reduce the return of the funds.

3. Actively managed funds rely on timing the market. That is selling high and buy low. This is quite difficult to achieve and and as a result the return is less that anticipated.

Hence the index fund or the passively managed mutual fund is the best bet to achieve a return that is as close to possible to the average return of the market. The fees of these funds are low because the funds do not need to pay a lot of researches and fund managers. They also mostly rely on the buy and hold strategy thus reducing the need to try to time the market.

Although funds that try to actively time the market and employs famous fund managers are quite attractive, history tell us that they always underperform the market so keep away from them.

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