Andrew Hallam is the index investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
Many professional investors sweat over the economy, dissect company balance sheets and watch stock market trends. I don't want to sound smug, but I don't have to do any of that. And my investment returns still hammer the returns of most professional investors, without any effort at all.
The sweet part is that you can do this too, with a diversified portfolio of low-cost index funds.
I can hear what you're thinking. Couldn't you pick individual stocks on your own or hire a guru to produce market-beating returns for you? Sadly, neither approach is likely to be a winner.
For proof, look at the rarefied world of hedge fund managers. If you're rich enough, you could hire one of these high-priced experts to produce some money magic for you. With their fingers on the pulse of the economy and no limiting regulations, hedge fund managers are free to buy and sell whatever they want: stocks, bonds, gold, currency futures, vintage Cabbage Patch dolls. They can even "short" the stock market, placing bets when they think the markets will fall, then collecting on those bets and making money if they're right.
But for all the headlines that high profile hedge fund managers generate, it's easier than you might think for a typical investor to hammer the returns of the average hedge fund manager. Since 2003, a simple balanced U.S. index with 60 per cent stocks and 40 per cent bonds has pounded the HFRX Global Hedge Fund Index by roughly 67 percentage points.
True, hedge funds are handicapped by the high fees they charge (usually amounting to 2 per cent of assets per year and 20 per cent of the profits). But those fees aren't the only reason they lag so far behind. The simple truth is that it's terrifically tough to beat a portfolio of low-cost indexes, and most professional money managers know it.
Ted Aronson, one of the most respected active investors in the United States, gets paid to buy individual stocks and bonds for the $25-billion (U.S.) he manages for retirement portfolios, endowments and corporate pension fund accounts. If beating the market with small cap or dividend-paying stocks were easy, Mr. Aronson would be doing it with his personal money. But he doesn't. Instead, he invests most of his family's capital in a simple portfolio of low-cost indexes. Over the past decade, his indexed returns have averaged 8.7 per cent a year.
When interviewed by CNN Money, Mr. Aronson said, "Once you throw in taxes, it just skewers the argument for active management … indexing wins hands down."
Not only does indexing beat most hedge funds, it also surpasses the results achieved by the majority of pension funds. When U.S. consulting firm FutureMetrics studied the performance of 192 U.S. corporate pensions, they discovered that more than 70 per cent of them underperformed the results of a balanced index between 1988 and 2005.
Merton Miller, a 1990 Nobel Prize winner in economics, agrees that indexing is the way to go. He says that "any pension fund manager who doesn't have the vast majority – and I mean 70 per cent or 80 per cent of his or her portfolio – in passive investments [index funds] is guilty of malfeasance, nonfeasance, or some other kind of bad feasance!" Yet many investors still think it's easy to beat the market.
If you want to follow a stock market guru or invest in an actively managed fund, consider it sport. Sure, it's fun to fool around, but if you're serious about making money, put the odds in your favour. Investing is a marathon, not a sprint. Build a portfolio of low-cost index funds and stick to your game plan.
You'll beat most professional investors over your lifetime, while barely lifting a finger.
See Andrew Hallam's model portfolio here.
And watch and participate as our value, growth, dividend and indexing strategists look for promising investments in Strategy Lab.
Andrew Hallam