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don’t look for better than average returns

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I’m rich!!!You can tell that it’s coming towards the end of the financial year when you start seeing lots of adverts for investment funds.

The other day, I was on a business trip to London and there were several ads in the tube, all for fund management companies looking for investors. I’m not against them advertising, after all, they have to make a profit and so need customers. However, just buying an investment from a fund manager is almost never the cheapest way of doing so - fund supermarkets and/or discount brokers can get you the same product cheaper.

In addition to being one of the more expensive ways of investing, the fund management companies were selling themselves on their desire (and implied ability) to beat the market. These are dangerous words.

Most novice investors think that beating the market is a good thing. And, they are of course, right. If you do beat the market and make money, that is good. Trouble is, wanting to beat the market, and actually doing so, are not one and the same.

I’m a big fan of just settling for an average return.

That’s because you can get an average return (minus tracking errors and fees). If I invest in an index fund then it’s performance will track the index - that is to say, it definitely will be average. Which means that it won’t do worse than average.

Pretty good going, when you consider how many investments that aim to beat the market, in fact do worse than the market average. After all, not that many people start off by thinking that they want to do worse. But if someone does better than average, then someone else must have done worse - that’s how averages work.

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18 comments for “don’t look for better than average returns”

  1. I’m a fan of index trackers, but they are still managed funds (they’re just managed with different objectives), and will have a tracking error rate. I was interested to see at fool yesterday that my index tracker (Fidelity) isn’t performing as well as Legal & General (although I think L&G might have a commercial relationship with fool!) http://www.fool.co.uk/news/your-money/2008/02/12/an-easy-way-to-invest-in-shares.aspx (sorry, no time to code the link).

    I’m not so bothered about tracking error, but it’s another thing that will sway me towards L&G; Fidelity’s response to the Amnesty International campaign to stop its investment in genocide was pretty poor, in my view. (not that L&G would really be any better..)

    Posted by Pippin | February 14, 2008, 12:29 pm
  2. I would be interested to know your view on Ethical funds. Most of the big UK investment lot, like L&G and fidelity et al have them. These are obviously not indexes, but representative companies from within the all-share or ftse350.

    Posted by Llama for brains | February 14, 2008, 1:23 pm
  3. Like you, I’m all about averages. That’s quite enough for me.

    Llama for brains, one ethical index-type fund I’ve heard of is the Domini 400. It has some of the S&P 500 companies removed and a few replaced. http://tinyurl.com/29oczq

    They advertise based on just barely beating the S&P 500. Of course, past isn’t a measure of future. What they do have going for them, though, is a pretty decent record of tracking the S&P 500 (the link above shows their performance). That seems to show that they’re good at running it like any other index….

    Posted by Mrs. Micah | February 14, 2008, 1:33 pm
  4. I would actively plump for average before “potentially world-beating”. Why? Because I’m just the sort of person who, if I tempt fate, ends up with egg on my face.

    Nice safe returns… That ticks my boxes! I’d be interested in any advice about how to go about first time investing for a complete nonce…

    Posted by Annie | February 14, 2008, 2:41 pm
  5. I am generally happy with average returns. . .but I have started putting a little ‘play’ money out at Lending Club. If it doesn’t work out, I will not have lost much, If it does work out, so much the better!

    Posted by rocketc | February 14, 2008, 3:13 pm
  6. @ rocketc:
    There’s nothing wrong with trying stuff out when you know what you’re doing, it’s the preying on those that don’t know better that’s not so good.

    Posted by plonkee | February 14, 2008, 4:44 pm
  7. @Annie:
    I’m exactly the same. At least I’ve wised up enough to stop messing with things that I don’t know about.

    I’ll write something on how to go about investing soon - if there’s anything anyone particularly wants covered, let me know and I’ll put it in.

    Posted by plonkee | February 14, 2008, 4:47 pm
  8. Hello there!

    To me it seems like you’re saying that compared to an index average there’ll always be investors that will outperform and some that’ll do worse.

    That’s not necessarily true, while it actually is true. Eh. :)

    The index average is not directly related to the average return of investors. All investors can beat the index, without the index average beeing altered - it basicly doesn’t measure those data. The index measures the performance of the stocks, not the stock pickers.

    But, a part from that small point, settling for average may be good.

    I’ll try to be brief, a fund that gives you a return of, let’s say, 20% above index average is usually a fund that takes a larger risk (higher standard deviation) and are usually very volatile. A fund which has an average performance, let’s say +-3% compared to the index which best represents the diversement of the fund usually has a lower volatility and standard deviation.

    Those funds which scream high returns are usually narrow sector funds etc, while those who gets average returns are broader funds like global funds and so on.

    This is all really a matter of diversifying your portfolio.

    Anyhow, there’re actively managed mutual funds who regularly beat the index they compare against. And it’s rather easy to check out which ones has the best ratings on morningstar, moodys, s&p, lipper etc.

    It’s like investing in stocks, you pick well managed companies who have a sound economy and people who excel at what they do. Use the same criteria for when picking your actively managed mutual fund, if you want one.

    Posted by Toka Kverlin | February 14, 2008, 6:26 pm
  9. I’m mostly of the opinion that over the long term it’s as difficult to pick a managed fund as it is to pick the underlying investments, and I can do neither.

    If you could have a global index that tracked the performance of the world economy, then it would be true that the average of that index would be the average of investors as there wouldn’t be anywhere else for them to hold there money. A general index won’t definitely have the same characteristics, but if it’s well diversified, it’s likely to be similar.

    Posted by plonkee | February 14, 2008, 8:42 pm
  10. Risk=Reward
    Too Much Risk= No Reward, no principle and your car repo’ed

    It is important to make sure that you aren’t so conservative that your are getting too low of a return. I believe that risk mitigation is important in a ratio to time left until retirement. But make no doubt there are gonna be up 20% some years and down 10% some years, that why you need to look at the long term!

    Marathon, not a sprint

    Posted by RacerX | February 14, 2008, 9:54 pm
  11. I’d just like to point out that getting the index return minus a small fee (say 0.5%) is not “settling for the average”.

    The average investor in mutual funds gets around 1-2% less than the index so a proper index investor is definitely above average.


    Posted by Four Pillars | February 15, 2008, 4:32 am
  12. Interesting point, Plonkee. I definitely go with average a lot, and am almost completely invested in index funds. But a part of me still wonders if I can beat the average in some way. Not enough to take a risk though!

    Posted by Chief Family Officer | February 15, 2008, 4:37 am
  13. @Mike:
    You’re right, the average return of the market is usually better than the average return of individual investors because they are more likely to chase performance and they have fees (in the UK, on average 1.8%) to subtract from any earnings.

    Posted by plonkee | February 15, 2008, 9:10 am
  14. I don’t see anything wrong with going for the average, if that’s what you’re after. I also look at other investments though than just in “the market”, like rental real estate and other businesses.

    Posted by Fiscal Musings | February 15, 2008, 2:53 pm
  15. @Fiscal Musings
    I’m not into property and other businesses at the moment because they require too much work, but they are certainly potential ways to beat stock market returns.

    Posted by plonkee | February 15, 2008, 4:24 pm

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