“It is not necessary to do extraordinary things to get extraordinary results.”Warren Buffet
If you got an impression from the above heading that it is is easy to outperform the actively managed mutual funds , you got it right . Yes its easy and simple. You don’t need to do extraordinary things, you will find below a simple strategy to outperform 90 % of the professional’s. Many of the investers already know the strategy. But If you are new in stock market, the chances are you are like me and perhaps millions of investers who came to know this ” well guraded secret ” of the mutual fund industry quite late. Here is some back ground before I go to the simple action plan.
Actively Managed Mutual Funds performance
Currently trillions of dollars are being managed in US alone in actively managed mutual funds. Investers pay a fee for getting a poor performance. The funds charge typically 3 percent (including hidden costs fee annually. To a novice invester it looks like a small fee but it becomes a hefty amount in a longer periods of time. Lets take an example. If you invest a $100,000 in a mutual fund that charges a 3% annual fee you end up paying $ 60,000 (or usually more than that) in 20 years and if you keep it invested for 30 years you pay upward of $ 90,000 or more. This money is gone from your account forever , if it were still in yur account it would have continued to earn potential profits in the stock market. To add salt to the injury ,over 90 percent of the actively managed mutual funds underperform the market average over long periods of time. For some evidence of this please click here , especialy look at the pie charts.That means you are paying a fee for their inferior performance. Yes a small percentage of fund managers , less than 10 percent perform better than market average but its never sure if they will outperform next year as well.Past performance is not a guarentee for future returns. You can see scorecards and persistence reports on SPIVA website that are a clear evidence that the few funds that outperformed one year failed to do so in subsequent years. I am reproducing one report from the SPIVA website , for more information see the website .
Hedge Funds Performance
You may think perhaps the fund managers will protect you in bear markets. Even thats not true. For example during the market crash / slide of 2008 -2009 the mutual fund managers again underperformed the market averages. How about the hedge funds who charge a hefty fee ( typically 2 % annual fee plus 20 % of profits )) and are reserved exclusively for very wealthy individuals and institutions. The hedge funds are supposed to protect the investers from losses and to maximize returns. You would certainly like to know the Warren Buffet’s opinion about hedge funds . He actualy placed a million dollar bet on this assertion : over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses .He won the bet and donated the money to a charity. The hedge fund’s cumulative return for this period was 24% and the S&P 500 return was 94 %. That means $1 million invested in those funds would have gained $240,000. The index fund would meanwhile have gained $940,000. Please note that hedge funds typically accept funds over a million dollar.
Simple Strategy to outperform the professionals
Why not hear the advice directly from someone who is known as the smartest Investor , Warren Buffet.
Question: “What advice would you give to someone who is not a professional investor? Where should they put their money?”
Answer from Warren Buffett: “Well, if they’re not going to be an active investor – and very few should try to do that – then they should just stay with index funds. Any low-cost index fund. And they should buy it over time. They’re not going to be able to pick the right price and the right time. What they want to do is avoid the wrong price and wrong stock. You just make sure you own a piece of American business, and you don’t buy all at one time.”
And Buffett’s follow up response: “And you won’t get that advice from anybody, because nobody gets paid to give you that advice. So you’ll have all kinds of people telling you how much better they can do for you than that — and how if you just give them a wrap fee or commission or whatever it may be, they’ll do better. But they won’t do better.
“You will get a perfectly decent return over a 30 or 40 year period by doing what I suggest. And in the end, why should you expect more than that if you don’t bring anything to the party? Salesmen will tell you that you’ll get more — but you won’t…”
So here is the strategy based on Warren Buffet’s advice that he has been giving from time to time to invetors who are non professionals.
- Invest in a low cost index fund .
- Don’t buy it all at one time. Do dollar cost averaging. For example you may invest $1000 , or $ 500 or $ 100 every month. When stocks are cheaper you will get more shares , when stocks are expensive you buy fewer .
- Hold the index fund for long periods , 20 or 30 years.
The index funds are passively managed. They mimic the results of the index they track. The most popular index fund is Vanguard’s S&P 500 index fund ( 0.04 % annual fee ) and it mimic’s the result of the S&P 500 index .What is an index by the way. An index is a basket of or list of stocks. For example S&P 500 index is a list of top 500 companies ( by market capitalization) chosen by Standard and Poors . These 500 companies come from all industries .Currently about 25 % of the companies are from Information Technology . Here are some of the top companies in the S&P 500 index
- Microsoft Corp.
- Apple Inc.
- Amazon.com Inc.
- Facebook Inc. A
- Berkshire Hathaway B
- Alphabet Inc. A (GOOGL)
- Alphabet Inc. C (GOOG)
- JP Morgan Chase & Co.
- Johnson & Johnson
- Visa Inc. A
Instead of buying all the 500 stocks individually , you can buy a small piece of the basket of these stocks through a S&P 500 index fund at a very low cost. You can buy the fund directly from the fund company or through your brokerage account or even better buy an echange traded fund ETF which mimicks the index that you wish to track. More on this below .
Simple Action Plan:
- Open a brokerage account if you allready dont have one. I would suggest choose a discount broker. Some brokers charge no fee when you buy ETF’s. Canadian investors , discount broker Questrade does not charge any fee when you buy ETF’s. This is particularly helpful when you buy ETF’s every month and save fee every month. When you sell ETF’s Questrade would charge you a small fee $ 5 to $ 10. U.S. Investors, Discount broker Score Priority allows you unlimited number of free trades of stocks and ETF’s , no fee . Please do your own research when choosing a broker , check their reviews , compare fees and comissions. A tip for Canadians if you buy US index funds such as VOO in your RRSP account your dividend income will be exempt from U.S. tax.
- Buy Vanguard S&P 500 ETF (VOO). Vanguard annuall fee is only .04 % for ETF’s . A typical actively managed mutual fund charges a 3 % fee which is about 50 times that of a typical index fund . For those who are new in stock market , the ETF’S trade just like stocks. If you wish to know more about VOO Or ETF’S in general please click here.
- Buy every month or biweekly keep adding to your portfolio.
- You may research about other ETF’S that track other indices and buy and hold.
Warren Buffet has extraordinary stock selection skill only few can match. After he is gone here is how he wants his heirs to invest the money. The following is an excerpt from his annual letter to share holders year 2014 :
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 Buffet