Is Investing Difficult Because It's Too Simple?
You don't have to go very far to find opposing advice on investing, especially on specific investments. The same firm may argue within itself what the best decisions are and at times, investors aren't even sure if they agree with their own choices. There is often a debate over whether to select individual stocks or stock funds. Of course, within this debate, the question is posed of whether to select actively managed funds or passively managed (index) funds.
From what history can tell us, about 20% of actively managed funds outperform the indexes and the funds that attempt to mimic those indexes. Those odds aren't too great, so why do people still believe their actively managed funds are going to beat the market? There are a couple reasons, both psychological, but first let's look at what is supposed to be "the real argument".
"My Fund is Better Than Your Fund"
It's often believed that if you want to beat the market, you've got to be willing to pay a price and that price comes in the form of high loads and fees. Historically, there have been some cases of high-load funds outperforming the market, but for how long? How long must you beat the market to get your money back and by how much? That is the question.
As if taxes aren't enough, these rockstar mutual funds are charging all kinds of fees and high loads, so obviously the first step is getting back to even. In other words: you've overlooked an index fund to invest in an actively managed fund, so you've got to at least beat the index by enough to break even, right? Then you have to beat it by a little more to consider your decision successful. Otherwise, all your searching through the funds and fund managers was for nothing.
If you're trying to beat the index with a fund, just know that the odds are against you. It's often believed that the statistics on index funds outperforming actively managed funds are inaccurate, because people who are looking for actively managed funds aren't going to pick a fund manager who doesn't beat the market. That makes sense, but as any average investor on Wall Street knows, the past has little weight on the future, with investing. A fund manager's past performance doesn't guarantee anything.
The Psychology Behind Active Funds
So why the active funds? It doesn't take a rocket scientist to figure out that passively managed funds are a better choice in almost every case. Not only do they typically outperform actively managed funds, but the fees are lower and you don't have the hassle of searching out the "top fund manager" if such an individual actually exists. So why then? Seriously, why the actively managed funds? Because it's all a game. A mental game.
The Complexity of it All
"A complex investment decision must be a good decision" or at least that's the mentality that often goes along with the idea to select an actively managed fund. In other words, the less I can understand it, the better. First off, any beginner investor likely knows that you shouldn't invest in that which you don't understand. Second, complexity doesn't equal profitability. If anything, it's the opposite, at least in the investing world. It's a common belief that more buying and selling leads to a higher performing fund. The truth is that the more you trade, the more you lose. That's why a passively managed fund can easily outperform its active counterparts. It doesn't end at complexity. There's another mind game going on here.
Someone to Blame
A common belief as to why actively managed funds are still so popular has to do with where the blame lies. If you pick your own index fund and the index falls, it's your fault for picking the fund. If you pick the fast-talking, hottest fund manager in town, it's their fault when something goes wrong. It's all part of the "hand-holding principle". Investing seems difficult at first glance, so it's easy to want someone else to make your decisions for you and it's also nice to have someone to blame. Nowadays, investing through one of the major investment firms (TD Ameritrade, E*Trade, Vanguard, etc.) is so easy, anyone can create an account, deposit some money and invest in an index fund.
The days of the Wall Street pros knowing it all and the common man knowing nothing are over. Investing is much simpler than most people want to believe. It's difficult for some people to accept that it can be as easy as choosing a few passive index funds, investing a certain amount monthly and passively creating wealth for your retirement. It really is that easy. If you're investing in index funds, you can sit back and know that the market will go up, the market will go down and all you're responsible for is rebalancing your portfolio once a year.
The difficult part is the discipline factor. It may be better if investing were harder to understand. Then, simply absorbing more information would mean you’re a better investor. That’s not the case. Investing is simple. You don’t have to be a genius, but it does take the discipline to make it happen.
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