What are common mistakes investors make and how can I avoid them?
What is the best way to invest money in the stock market?
What is the difference between active and passive investing?
Should I invest in index funds?
These are questions investors often ask and here are some of the common threats investors face:
Threat 1: The Expenses of an Active Market
Most of us would like to beat the market, but as you will learn in this whitepaper, most professional money managers have had a hard time performing better than the market. To understand why, it is helpful to begin with some definitions.
Active investors (and active money managers) attempt to out-perform stock market rates of return by actively trading individual stocks and/or engaging in market timing — deciding when to be in and out of the market.
Those investors who simply purchase “the market” through index or asset class mutual funds are called passive or “market” investors.
Active mutual fund managers are typically compared to a benchmark index. For example, large cap mutual funds are often compared to the S&P 500 index. To beat the index, an active mutual fund must perform better than the weighted average return of those companies in the index. And they must do so while including fees, taxes, trading costs, etc. so they report a real rate of return.
A lot of time and money is spent attempting to “beat” the market. Professor Ken French of Dartmouth’s Tuck School of Business estimates that investors collectively spend $102 billion per year in trying to achieve above-market rates of return.2
Professor French added up the fees and expenses of U.S. equity mutual funds, investment management costs paid by institutions, fees paid to hedge funds, and the transaction costs paid by all traders, and then he deducted what U.S. equity investors would have paid if, instead, they had simply bought and held a passive fund benchmarked to the overall stock market. This $102 billion difference, Professor French says, is what investors, as a group, pay trying to beat the market.
Threat 2: Many Active Mutual Fund Managers Have Failed to Beat the Market
As you can see from this chart, over the five-year cycle from 2007 to 2011, the vast majority of active mutual funds underperformed the stock and bond markets.
Though past performance is no guarantee of future results, notice how many of the money managers’ average annual returns were below the average returns of their benchmarks. For example the average return for all Large Cap funds during this period was more than 1% below the Large Cap S&P 500 Index.
Click here to view complete Wealth Guide titled: 8 Threats To Portfolio Performance