If you really want to know my opinion: Don’t invest anything abroad that you are not willing to lose. Of course there are investment opportunities all around the world. And you might even benefit from some sort of diversification, if you spread your assets far and wide. But the reasoning why some “golden opportunity” on the other side of the globe should be waiting just for you, escapes me. There are investors everywhere, and someone in a far-away country probably knows his local market a little better than you. Even if you’re a top-class investor at home. And, above all: the currency. You will be investing in a foreign currency. You’re investment in a foreign market may indeed climb through the roof; but what good is that, if its currency drops twice as much? Currency fluctuations may be a real killer. And a killer argument against foreign investments.
Most investment advisers will tell you to scale back your stock allocation as you near retirement. But age is just one (crucial) factor in your asset allocation. The other variable is your risk appetite or risk aversion. Most often, investors are categorized as either conservative or aggressive or something in between. If you don’t like too much risk in life in general and in investing in particular, a rule of thumb would be as follows: Take 100 and deduct your age; this would be your asset allocation to stocks. So if you are 40, you would “be allowed” to invest 60% of your assets in stocks (100 – 40). If you consider yourself to be a daredevil investor, you might want to take 120 and deduct your age. In our example that would leave you with 80% stocks at age 40 (120 – 40). If you’re neither particularly conservative nor outright gung-ho, your asset allocation to stocks would be somewhere in between. There are a couple of caveats, however. Even a “low” allocation of 60% to stocks may be too much for many 40-somethings. If that’s your case, don’t worry: You’re not alone, there’s nothing to be ashamed of. There’s many a fund that caters exactly to your financial needs. And then this calculation is nothing but a general guideline, an approximation. The asset allocation that’s really right for you may deviate quite substantially. On the other hand, we shouldn’t forget that life expectancy today is still a few years beyond 60. You may even live to be 100. So you might consider keeping some of your assets in stocks well beyond your official retirement age.
Even small amounts add up over the long run. There are worlds between operating expenses for mutual funds of 1% or 2% per year. And don’t forget the miracle of compound interest that you give up on that difference which you might call “minute”. If 1% more or less doesn’t matter to you, I have a suggestion: Send me your e-mail address; I will then send you my bank account number, and you’re welcome to transfer the money you are willing to give up for some fund management company directly to someone who deserves it – me.
It’s so unfair. You own shares in a mutual fund. Each one of them is worth 100 dollars. Now they drop 50% down to 50 dollars. That’s bad enough. But if you thought they would just have to climb back those 50% and you’re back where you started, pull out your pocket calculator: How much is 50 + 50% of those 50? I think it’s 75 (and not 100). As a matter of fact, you need a hike of 100% to get back to 100 from 50.
Of course you’re not really willing to lose 100% of your investment. But you should at least be aware of the fact that it might happen. No matter what you invest in. But of course more likely with stocks than bonds, for instance. Whatever you do, whichever investment you choose, there is always the possibility that it might tank. Totally. No prisoners taken. No money returned. That’s the simple reason why you should a) never invest all your money and b) only invest money that wouldn’t kill you, if you would lose it all.
Not everybody agrees on what short term, medium term or long term exactly mean when it comes to investing. In my view, three stages make sense: Short-term investing: If you want to invest your money (or some of it) for up to 2 years, I think you might call this “for the short term”. If you’re pretty sure that you will need that chunk of your fortune pretty soon, parking it in a money market fund (in your home currency) may by the best bet. The drawback is, of course, lousy interest rates. Medium-term investing: If you can do without the cash for 2 to 10 years, you should look at the great range of bond funds that are available for you in many shapes and forms. The risk you take may be a little bigger than with a money market fund, but so are potential returns. Long-term investing: If you want to stash away your money for 10 or more years, take a look at the possibilities the stock market has to offer. I’m not saying, go all out for stocks – there are other factors to consider as well. Just think of your risk appetite or, rather, aversion.
If you think an index fund is the most boring investment in the world, you’re entitled to your own opinion, but I beg to differ. Index funds provide broad market exposure, low operating expenses and low portfolio turnover. Since the fund managers of an index fund are simply replicating a benchmark index, they do not need research analysts and others in the stock selection process, which lowers ancillary expenses. Index funds have a certain academic logic. If you believe in the efficient market hypothesis (which says that in the long run nobody, not even you, can beat the market), it may be better not even to try. In other words: If you can’t beat it (the market), join it. Investing in an index fund doesn’t guarantee you that you’ll never lose money. Oh, no. You will go down in a bear market just like almost everybody else. That’s life. So you may find passive index investing boring. OK, go ahead and lose your money with an active money loser. I’m sure you’ll find one.
You invest money that you don’t need – right now. I hope we’re on the same page in this respect. But for how long don’t you need your money? Many investors misjudge their time horizon. They think they can do without their investments for years, when actually they need it before year’s end. Or something unexpected happens and all of their long-term plans are null and void. They may get into a car crash, they might lose their job, they divorce. There are plenty of reasons why long-term financial planning may take a wrong turn and you desperately need money now that you hadn’t planned on touching for years to come. So think long and hard, before you make any investment decisions for the long term. Better be safe than sorry.
Mutual funds are run usually by teams of specialists, from the fund manager to securities analysts to economists to administrators. So in a way, the fund manager is just a fund’s face. Of course there are good and not so good fund managers. But do any of them really excel over the long run? Are some of them consistently better than their peers? Perhaps and perhaps not. It’s probably easier to weed out the worst of them than to pick the best. And how could you as a regular investor find out who’s good and who’s not? You can’t. If you find that a mutual fund has an inferior track record over the past 10 years, chances are that the fund manager won’t turn it around just because you decide to invest. And the other way round, an historically superior fund or fund manager may sooner or later lose his Midas touch – probably right at the moment you decide to go in. You just have to live with it: You might get lucky and you might not. One caveat however: There are no investment gurus. Don’t be blinded by smug smart-alecks; the louder they scream, the less they have to say.
Of course you’re curious about a fund’s past performance. There are at least two caveats, however: First, you may want to consider risk as well. A mutual with a stellar performance may have taken such high risks that you would be uncomfortable owning it. Second, a one-year performance figure has only limited significance when it comes to longer term success. The fund manager may just have been lucky. Or he may meanwhile have left the company and left the fund in the hands of a nitwit. Whatever: The majority of top-performing mutual funds in any one year underperform their peers in the following 5 to 10 years. Some of them even went all the way to the bottom of the league table. This is so remarkable that I’m glad to repeat it: The majority of top-performing mutual funds in any one year underperform their peers in the following 5 to 10 years. Some of them even went all the way to the bottom of the league table. And you ask why you shouldn’t just buy last year’s top-performing fund?
Mutual funds are no different than supermarket products when it comes to price and quality. If the price is ridiculously low, it’s probably trash. If it’s a food product, it was probably produced under the most appalling conditions with factory farming and unimaginable pain for the animals. Unfortunately, the reverse is not true. You may pay extra high loads, commissions or management fees and still get inferior results. Ridiculously high costs may indeed even be a factor for bad performance: As an investor you first have to “recover” all the costs you have to pay, before your fund can start to deliver positive returns. Of course, this does not apply to ETFs. They are inexpensive due to their structure and composition.
Robo advisers are the latest investment craze. These are online platforms that offer automated investment advice based on algorithms. Thereby, the clients’ investment needs as well as their risk appetite and capacity are assessed by means of an online questionnaire. This results in a model portfolio. From time to time, this portfolio may be rebalanced, again fully automated. In a way, this is like an inexpensive asset management mandate you might get from a bank – the bank evaluates your positions on risk and your investment goals and defines a model portfolio. What’s interesting in this context is the fact that robo adviser portfolios are usually made up of index funds or ETFs. Once again, these funds prove their superior investment qualities. They are simply the best tools to assemble, monitor and rebalance a portfolio’s asset allocation.
Recently another well-known money manager shut down his hedge fund after a year of disappointing results: Eric Mindich, one of those self-proclaimed Wall Street wunderkinder, had launched Eton Park Capital Management in 2004, expanding it to manage as much as $14 billion. In a letter to investors he blamed challenging market conditions and poor performance. The hedge fund’s assets under management had fallen by half since 2011. And guess what: As from 2018, this great hedge fund will no longer appear on league tables; it will simply disappear from hedge fund indexes, proving once again that hedge fund indexes aren’t worth the paper they are written on. Survivorship bias at its worst.
Diversification is great. It reduces risk, you know that by now. So wouldn’t it be great to further reduce risk (and increase potential gains) by adding hedge funds to one’s portfolio? Rubbish. Hedge funds are bad news. They add to your overall risk without providing anything for the upside. Adding hedge funds to your portfolio does not spread your risk any further, it will just lower your performance (due to the rip-off fees they charge) and drag you down (due to their inferior results).
A typical mutual funds will cost an investor 1 or perhaps 2% in fees a year. A typical hedge fund will charge around 2% a year as a fixed commission plus 20% of all profits. Why? Because there are investors who are stupid enough to believe that hedge fund managers are so smart that they are worth every penny respectively every percent. Unfortunately they are not. They don’t have a higher IQ than your regular fund manager, they don’t have a crystal ball to see where the market is headed; all they have is less regulation and more freedom to line their own pockets. Not a fan.
There are mutual funds that follow an absolute-return strategy. Their goal is to make money (or at least not lose any), no matter which direction their target market takes. If the market goes up, the fund goes up; if it goes down, it also goes up. This is not a typo. It’s a marketing gimmick. Absolute-return funds are always the loudest after a market has tumbled and investors are sick of losing money. In come the absolute-return promises of making money in every market environment. For one thing, hedging one’s bets (buying investment instruments that counter a market’s decline) comes at a cost, even for a mutual fund: The fund’s performance automatically declines corresponding to the hedging costs. But even more importantly, actual results may differ from pompous promises. If you find an absolute-return fund that hasn’t lost money in any single year over the past decade, tell me all about it.
Absolutely not. They are here to stay and grow and expand and make many an investor happy. And others not. Exchange traded funds (ETFs) are like mutual funds with a basket of stocks or whatever, that trade like shares on a stock exchange. They track a pre-defined index such as the S&P 500. ETFs are mostly passive investment vehicles with low overhead and therefore an inexpensive way to cover an entire market or a market sector with a single investment decision. ETFs are great. All you have to do is ponder which market or market sector or perhaps which country or management style has the best prospects for the coming months. And then go and buy a corresponding ETF. And if you don’t like it anymore, you can sell it anytime on the same stock exchange you purchased it in the first place. But always remember: If you pick the wrong ETF (or any other investment for that matter), don’t blame anybody else but yourself and certainly not me. An ETF can’t buck the trend; if its market segment goes down the drain, it goes down with it.
Ever heard the term “survivorship bias”? This is not a badge of honor for the mutual fund industry – but even less so for hedge funds. Survivorship bias is the bad habit of fund companies to quietly close underperforming funds or merge them with better ones. Generally this happens either because of poor performance or because of declining assets (small funds may not be worth the trouble, financially and otherwise). Eventually only the better funds in a fund company’s portfolio survive. As a result, the fund company’s overall results may appear better than they actually are. However, the hedge fund industry is much worse in this respect (and in many others).
A mutual fund charges a management fee even if the NAV has gone down. Why? Because it has to pay its managers, who themselves have bills to pay, from groceries to their divorce settlements. Paying management fees (respectively, having them deducted from the fund’s returns) comes with the territory. If the market tumbles, it’s not the fund manager’s fault. He still has to get up early, leave for work, sit at his desk all day and so on. That’s why he gets paid (a management fee). Of course, if the market goes up and your fund still goes down (or can’t keep up with its benchmark), you have every right to be angry at your fund manager. But don’t forget that the fund itself does not live in a vacuum. There’s no way it can match an index one-by-one: The index is just there, the fund, on the other hand, has to track this damn index. And that costs money (monitoring it, buying and selling securities as the index changes and so on). So, if you want to be angry with your fund manager, first make sure that you don’t compare apples and oranges.
Asset managers and mutual fund managers are paid to beat the market. Being professionals, often backed by whole teams of analysts and assistants, they are supposed to be able to pick the best stocks, bonds or whatever a particular market has to offer. Unfortunately, not all of them succeed. You may have read about those comparisons when a monkey throws darts at a financial paper’s list of securities and one year later it turns out he did better than most pros. If a monkey can beat the pros, so can you. Right? Yes, of course. I’ve heard all about you, Mr. Stock Picker. But let’s be serious: The notion that Average Joe would be able to just go out there, pick a stock or two and beat the best full-time, experienced money managers sounds a little ludicrous to me. Of course you can argue that nobody will be able to beat the market over the long term (which may or may not be true). And of course you can claim the exact opposite (which may or may not be true). But it seems to me that a professional has a better chance to achieve superior returns than Mr. Stock Picker, who has to put in a 40-hour workweek before he can turn to his real calling, investing.