Picture this. You study up on investing strategies, do your homework, unearth some hot stock tips and then invest a decent chunk of money. Next thing you know, you’ve made a killing and can retire to live the high life. It’s a nice thought. Even if you don’t have such delusions of grandeur, you’d probably like to think that with a little effort and education, you could actively manage your portfolio and outpace market returns. How hard could it be? Think again. Here are three reasons you should give up your stock investing fantasies.
The Outlay of Time and Effort Involved
To become a successful investor, you need more than just the desire to make money. Educating yourself on the ins and outs of investing and the markets takes time. Additionally, you will need to do extensive research on individual stocks. All of this effort requires a person who is extremely detail oriented with a large amount of patience. And consider this...mutual fund managers who have virtually unlimited time to research, are well-educated in their field and have access to all sorts of resources still don’t usually beat market returns. Experts in investing spend hours every day on their craft. Even if they are willing to put in the effort, most people just don’t have this kind of time.
Costs Can Be High
One of the two main factors that influence investment returns is expense ratios. Actively managed portfolios and mutual funds carry more costs than index funds. A laundry list of advisory fees, account fees, exchange fees, 12-b1 fees, hidden transactions fees and many others can cut into your profits by as much as 3% annually. This means you have to get returns that are that much higher just to match the average. Compare that to the average .2% expense ratio for index funds. This makes a big difference in your return, especially over time.
You Probably Won’t Outperform the Market Anyway
Even if you have the time, inclination, patience, dedication and skills to invest on your own, chances are you still won’t outperform the market. Two-thirds of actively managed funds fail to outperform index funds. There are a very select few who can pick winning stocks that will beat the market every time, but this is rare. They are either incredibly lucky, extremely talented or both. Even the best fund managers only outpace the average returns for a year or maybe two.
Another big problem, even when you've done everything right, is investor behavior. As K said to J, "A person is smart. People are dumb, panicky, dangerous animals and you know it." One investor can do little to control mob behavior responses to world events.
How to Win at the Stock Market Every Time
So what’s the alternative? Index funds. Their costs are extremely low. Even though they may produce average returns in the short run, their long term returns are above average compared to other investment vehicles. And best of all, it doesn’t take a lot of time or effort to invest in them. You put your money in and forget it; the fund does the work for you.
Finding the Right Fund
There are several ways to get into index funds. The least expensive option is to go directly through a well-respected mutual fund company. The minimum to invest is usually around $3,000.00, but sometimes you can get in for less with automatic monthly contributions. You can also go through a brokerage firm, but you will have transaction fees whenever you buy or sell. Alternatively, you can use an investment advisor. However, this involves yet more fees; and despite what some advisors may tell you, when it comes to investing, spending more does not necessarily get you more. In fact, it may likely get you less.
Instead of trying to beat the odds and putting all that time and effort into trying to outpace the market by a small percentage, wouldn’t your time be better spent finding a reliable index fund? Take your time savings and invest it in finding new ways to cut expenses or make extra money so that you have more to invest and therefore, greater returns.
Cheryl Johnson is a part-time writer who loves to help others save money. If you are interested in having Cheryl write for you, find her at Textbroker.com under Cheryl24.