The Amateur Financier

So far this week, we’ve stayed pretty passive with our investment strategies.  Yesterday, we covered the basics of creating a portfolio from index funds and the day before, we covered an even easier method, using target date funds.  But what if you, like our (fictional) friend Charlie, want to try to beat the market?

“I’ve had good luck with index funds, but I’d like to try to beat the market.  Unfortunately, I don’t have the time I’d need to do research and successfully pick individual stocks.  How can I put my stock picking desires to the test without having to, well, pick stocks?”

Before we get into some ways to put your market-walloping desires into practice, let’s get through the standard warning: attempting to beat the market frequently fails.  One advantage of index funds is that you’ll always match the index’s performance (minus the relatively small expenses associated with the fund); while the techniques below might be able to beat the market, there’s no assurances that they will.  Consider the possibility for under-performance, if not outright losses, when trying to beat an index fund.  On that cheery note, one method of beating the index is…

Actively Managed Funds

The bulk of mutual funds fall into the category of actively managed, that is, funds that have a person (or much more likely, a team of people, with plenty of support staff) choosing which investments in which the fund will invest.  Besides increased diversity in your investment options, actively managed funds offer you the opportunity to beat the market, which is one of the biggest reasons that they continue to be a major investment options along with the cheaper index funds.

Choosing an actively managed fund is significantly more involved than choosing an index fund.  For the latter, you simply need to create your desired asset allocation, find the appropriate index funds, and fill your portfolio.  Actively managed funds are more complex; you’ll need to not only find an appropriate fund for your allocation, but also make sure that the fund will beat (or at least match) the performance of a comparable index fund.  There are plenty of sources to check when trying to find high quality actively managed funds; one worth checking out for some good suggestions is Kiplinger’s 25, a decent list of professionally reviewed funds to start your search.

When trying to choose a good actively managed fund, your primary concern should be to ensure that the manager is well seasoned and has the skills needed to outperform the market.  When researching the fund, there are plenty of resources to consider; one of the best is Morningstar, which can provide you with all the information you need for less than twenty dollars a month.  (It also has a pretty decent collection of tools and information available for free, just in case.)  If the manager has been outperforming the market consistently for an extended period of time (five to ten years, at minimum), that’s a good sign that they might (emphasis on MIGHT) be able to outperform the market in the future.

The Bottom Line

When investing in actively managed funds, you can potentially beat index and target-date funds.  This potential to beat the markets comes with the need to do lots of research, though.  While you just let index funds go, investing regularly without paying too much attention to how well they are performing (they’re going to mirror the index, after all), actively managed funds require that pay attention to the performance of the fund, the changing of the management staff, and whether the fund is drifting away from the stated portfolio goals. While index funds can be monitored quarterly, even annually, actively managed funds will need to checked regularly (at least monthly, preferably weekly) to ensure that they are still outperforming the index.  If you’re not beating the market with your fund, why pay a premium above an index fund, after all?

• Investment Mistakes in a Bear Market
• Where To Find A Mutual Fund Expense Ratio
• How To Determine Mutual Fund Holdings With Morningstar
• Back to Basics and Mutual Fund Survivorship Bias
• Morningstar: Go-Anywhere Funds Beat The Market Heat