Have you seen banks or investment firms promoting their investment funds like mutual funds or unit trusts?
It does sound like an intelligent idea to rely on the expertise of professionals to make up for our shortcomings.
Because these investment funds provide a promising concept:
Their smart and well-trained fund managers will help you invest & diversify your capital into multiple different investments. And you just have to sit back and collect the earnings.
It is a great option for individuals who are not financial savvy and unsure about what investments to make.
But do you know that more than 90% of the time, these actively-traded (managed by people) funds do not “beat the market”?
Meaning you often actually lose money and would actually earn more if you simply invested in a passively-traded (managed by computers) index fund instead.
Don’t get me wrong, some of these funds do “beat the market” sporadically. They may earn an astounding 20-30% annual return in a particular year.
But the key word here is CONSISTENCY.
For every “good year”, there would be other years where the funds lose money.
Most fund managers have a good 12 months but a terrible ten years (source: The Economist).
We want an investment which increases consistently and keeps growing year after year.
If you compare the results with an index fund over the long term (10-20 year time frame), the index fund always wins.
Warren Buffett himself actually advised his own children to withdraw from his investment firm & invest in index funds after he dies:
“My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.” – Warren Buffett
Warren Buffett even made a wager of USD$500,000 against any fund that could beat the S&P 500 index fund over a ten-year period. True enough, no fund won. None managed to beat the S&P 500 (source).
We do not have an equivalent of the S&P500 which tracks the top 500 companies on the USA stock exchange. Instead, we have the Straits Time Index (STI) which tracks the top 30 companies on the SG stock exchange. The value of these 30 companies is equivalent to around 75% of the total SG stock exchange market cap.
Beating the market is a myth. Only a very small number of funds beat the market consisting each year, and of those an even smaller number can convincingly claim it was due to skill rather than luck.
(One rare example of such a rockstar fund is managed by Warren Buffett under his company, Berkshire Hathaway.)
Then why do people still invest in actively-manged funds?
The simple truth of the matter is that most people are still looking for the miracle “silver bullet” which can help them get rich quick & easy, without much work.
And these actively-traded funds are very good at selling this dream! Even though they rarely fulfil this promise.
Moreover, investing in an index fund is boring. Even though an index fund has the best expected return for your money, it’s never going to double your money in a year.
A sexy hedge fund, no matter how unlikely, could potentially do this. Some people get seduced by the possibility of 10x their investments in a short period of time, no matter how low the odds.
Even if they lose money in the end.
Better luck with lottery, perhaps.
For the rest of us, let’s stick to proven investment strategies that provide steady returns over our lifetime.
Hat tip to Dylan James’ post on Quora for inspiring this post.
Do you invest in any investment funds like unit trusts or mutual funds? How is that working out for you? Are you earning money yet?
Agree or disagree? Let me hear your thoughts in the comments section below!