Two quick questions: I’ve been doing a very tiny amount of reading regarding savings and mutual funds and such, including some of the dread Malcolm Gladwell. Unless there’s a massive load of scholarship money for Harry Potter trivia, I’m going to have to find some money for college someplace.
Index funds: These make sense to me, since you’re assuming that nobody knows what the market is going to do, or at least the vast majority of market analysts don’t know, really, so your odds of doing better than the market are similar to your odds of doing worse. Plus you avoid the problem of a really bad fund manager. Is this correct? Do people who don’t go with index funds have an unrealistic expectation of the ESP powers of their fund manager?
Black Swan funds: I think Gladwell goes into some detail about this concept, but the fund no longer exists as such. I can see if someone had beau coup money, they might drop some change into one of these to hedge their bets. Do these exist anymore? Did any off them pay off big during the last financial crisis?
Any answers, explanations, pontification, comments, suggestions, recommendations, cartoons or interpretive dance on these issue is appreciated. And anything else related.
Most fund managers probably aren’t “bad”, but the majority won’t beat the market for you, before or after the small print.
You usually pay some fee to purchase a fund and the fund itself will have an expense ratio. Most of the low cost index funds have low (usually no) purchase fees, unless you flip it inside a 90 day window. And both Vanguard and Fidelity offer index funds with annual expensive ratios well under 0.2%.
So, for a regular mutual fund to beat or even match that, they would have to outperform the market by several percentage points, to account for fees and expenses.
As for people who go with managed funds, they don’t necessarily have unrealistic expectations of their managers. A well managed portfolio of diverse funds can certainly do well. But the investors don’t realize that the fees and expenses really do eat into any outperformance of the market. Beyond that, the various investment houses put out a ton of material showing how they do consistently ‘beat the market’ (before fees and expenses).
Also, it’s often easier to just hand a manager your money and tell them to invest it, rather than spending the time to build your own portfolio (even with index funds, you shouldn’t just put 100% of your money into a domestic stock fund, after all). Many people are willing to take a hit, if it means less work on their part. Even if most fund managers aren’t great, there aren’t that many that are actively bad, either. Most do about average.
Unfortunately, investors also often don’t realize that these agents have no fiduciary duty to any particular investor (especially small ones). They might toss out the old bone that they make money if you make money, but it’s not always worth putting in the extra effort for what amounts to an increase of a tiny fraction.
One big argument in favor of index funds is their extremely low expense ratio. Whereas an actively managed mutual fund might have an expense ratio of 1.2%, an index fund has an expense ratio around 0.2%. So if you choose an actively managed fund, it needs to exceed the performance of its relevant index by 1% just to match its net ROI to that of the relevant index fund.
Another argument is that with an index fund, there’s less buying/selling (by the fund manager) of individual stocks that make up the fund, resulting in lower capital gains taxes. This means that an actively managed fund needs to exceed the performance of its relevant index by an even wider margin just to match its net ROI to that of the relevant index fund.
Exactly. So a good or lucky manager will make me money, while charging me more than a low-fee index fund, and a bag or unlucky manager will lose me money, while charging me more than an low-fee index fund, and an index fund will produce more-or-less what the market produces, with a lower fee.
… provided that your portfolio incorporates the correct mix of investments to be properly diversified and that you know how to set your own goals.
I’m a huge fan of index funds, but there is value to having a manager who can look at your entire financial picture - cash, real estate, stocks, bonds, life insurance, etc. and make sure that this is consistent with your goals. Many of the people who pay fees to a investment manager are also getting services above and beyond picking stocks - they’ll get advice on how much to save for retirement, how much life insurance they need, etc.
IIRC black swan funds are not used for hedging. They keep most of their funds in safe investments like T-bills and a small amount in extreme longshot investments that short the market in some way that usually loses money every year. The T-Bill proceeds keep paying for losses on shorting the market, and if/when the market does tank, the shorts pay off greatly, offsetting years worth of underperformance at precisely the time when have a positive return is most valuable.
If you just want to hedge, there are much easier ways. Buy a bear etf that does the inverse of whatever your portfolio is, or just put money in T-Bills or keep it in the mattress. You don’t need a black swan fund for that.
I’ll upload my interpretive dance piece to youtube later. For 0now, if you are looking to invest for college for yourself, you probably have a time horizon of less than 5 years. So at most, realistically, you might see 30-60% (5-10% annual over 5 years) return in a secular bull market - which is what we seem to be in for the foreseeable future. Since you should probably assume the low end of the range, I don’t know if 30% is going to cut it - especially when you consider that costs even at state schools have risen dramatically.
As was said, a buy and hold, well diversified portfolio with minimal “churn” by the fund manager will give you the best chance of solid returns. But this means diversifying over asset classes as well to include real estate (REIT’s for example), bonds (different grades and maturities), equities, precious metals and commodities, etc.
If you need to double or triple your money, then you’re just gambling, because if that were easy to do, we’d all be billionaires.
Managed funds can be useful if they are directed to a specific investment objective, such as a fund containing dividend paying stocks used for income. The value of the stocks in such a portfolio might not match the market as a whole, but that might not be important.
To the second part of your question, there were some hedge funds who made a lot of money in the Financial Crisis by betting on what some would call black swan events. The particular fund that was started by the Black Swan guy Gladwell wrote about got out of the business. Since you are worried about paying for college they are probably not for you since most hedge funds do not deal with people investing less than millions.
The term Black Swan when referring to investments was first coined by Nassim Nicholas Taleb and was the title of his book on the subject. He manages money for clients but I believe you need to be Scrooge McDuck to afford his services.
Bob Brinker gets questions like this on a regular basis. His response has been that money that will be needed in less than 5 years should be considered short term. Don’t expose it to risk. Sorry, but as crummy as the interest rates are right now he’d probably recommend laddering out fully FDIC insured CD’s.