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April 18, 2014



Index Funds Beat Actively Managed; Now What??

I have information to share with you. Information that, when you learn it, could potentially alter your entire perspective on investing and money-management. This information could completely undermine your entire investing strategy. Are you ready? Here it goes:

Actively-Managed Mutual Funds Do Worse than Index Funds

Your mind is blown, isn’t it? Alright, probably not; this particular fact is pretty well known in the personal finance community, with just about every guru or other expert who recommends mutual funds at all suggesting to stick with index funds. It’s hardly new or shocking information for most of you.

If you can make more money while doing the investing equivalent of casually sitting on a bench, why not?

Still, there’s a fair chance that you aren’t actually putting this knowledge into practice. Too often, we end up investing fairly blindly, not taking facts about the general performance of different categories of investments into account as we put our money to work. So, let’s look at how we can approach investing in light of this under-performance by fund managers:

1. Stick with Index Funds…: If fund managers don’t really add much to your net worth, why pay so much to enlist their help? By sticking with index funds, you can cut down your expenses, make your research easier (no need to research the history of fund managers and measure their success over time compared to the appropriate benchmarks), and still probably end up with more money than by trying to pick the hottest fund in a particular field. Not bad for investments that require a bare minimum of research; if you make index funds the basis of your investments, you’ll be able to benefit from their profitability at your convenience.

2. …Unless You Are Looking at Areas Where Active Management Can Make a Difference: If you are still considering actively-managed funds, perhaps because you are hoping that you are able to find those few managers who can help boost a fund’s return enough to justify their cut of fund costs, you should know where to look. Large-cap fund managers, the ones most directly competing with the S&P 500, have a tough time beating the market; every company in the S&P 500 has dozens, if not hundreds, of analysts watching it at all times. The chances of a large-cap fund manager being able to consistently out-perform other funds, as well as the appropriate index, is quite slim.

But in other investment areas, active management can make more of a difference. In areas like small-cap funds and emerging market funds, where the number of potential investments is much larger and the amount of attention paid to each individual investment is much less, a manager could make more of a positive difference regarding your profit margin. It will require quite a bit of research in order to figure out the best managers to choose, but it can help to increase your net worth if you do it properly.

3. Keep These Areas In Mind For Your Own Individual Investing: Perhaps you want to try buying individual stocks or bonds. If so, you should probably stick with same areas brought up in the second point; you will find yourself in much the same position as the typical fund manager. You’ll likely have more luck if you try to find areas where not too many other people are buying. Small-cap stocks, emerging markets, and other areas that don’t receive much attention are likely to have more opportunities for good investments than large-cap stocks like those in the S&P 500.

Keep these points in mind while you invest, and you should simplify your investment life, while increasing your profit at the same time. Good luck, and happy investing!

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