This article is motivated nay a conversation with a friend who recently liquidated his assets, sold his house and invested upwards of €200,000 in a single mutual fund. Over the first year he was quite elated, given gains of nearly 8% – a nice result when you compare to bank savings, however, one must take into consideration the risk incurred in making that money. Ultimately, not every year in conservative investment funds will record positive gains.
The first mutual funds date back to the early 1920s, when the fledgling instrument first caught fire with investors. Over time however, they have garnered a very long history of performances, enduring world wars, the Great Depression in the United States, and a number of stock market crashes. And yet, after all of these stressful periods, a number of mutual funds have still survived and have even come out as winners. If you are willing to invest long-term and be disciplined, mutual funds are a great platform to help you reach your financial goals.
However, before hawkishly opening a new browser to put money into a mutual fund, it is important to consider that a mind-blowing 96 % of actively managed mutual investment funds fail to beat the S&P Index over any sustained period of time.
When we compare results of the S&P 500 (an index composite that includes top companies in US like Apple, Exxon, Amazon, and others) and the real value of the growth in the US stock market, we can see that more than 90% of the investors today simply do not yield proper investment allocation.
Of course, we do have funds that in some short period of time outperform the broader market, which marketing and sales guys push and subsequently sell, however in the long-term these are simply noise. Over a twenty-year period from December 31, 1993 through December 31, 2013, the S&P 500 returned an average of 9.28% and at the same time the average investor in mutual funds made just over 2.54% – a nearly 80% differential in gains.
Normally, mutual funds have much more historical data backing them, lengthier statistical backing, and invariably a longer-term view. Alternatively, many foreign exchange (FX) trading strategies can be tested up to six or seven years, during which traders can utilize the biggest drawdown monthly averages and other statistics.
Moreover, one important point to consider is that a manager you delegate to should be in charge of the same strategy used in his own personal portfolio. Interestingly, roughly 50% of fund managers do not hold the same portfolios as they manage, while the other 50% hold a very small proportion of the same funds they manage. We can liken this to the analogy, would you eat in the restaurant where the main chef would not eat himself?
Is it smart to invest in a fund when the same people who are running it are not investing in it? Trust should not idly be given, nor should we quickly make decisions of this magnitude.
I’m a big believer in technology and resources which are opening up new opportunities for investors. Today, market participants and traders utilize precise tools to evaluate investment strategies and weigh what money is at risk, respective to potential gains. With the advent of the FX market, exchange boom, and advanced trading algorithms, we are definitely operating in a new era of investment.
For example, let us weigh a strongly performing investment fund that we can posit reaches approximately 8% net return on a yearly basis. At the same time, if we have an investment yielding 50% yearly growth on average, we will also produce almost similar results. However, normally we would need to be able to risk at least 50% of the account.
Let’s take a closer look at the numbers:
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500.000 euro – 8% yearly average = 40.000 euro profits / Risk of 30% = 150.000 euro at risk
Currency Managed Account
80.000 euro – 50 % yearly average = 40.000 euro profits / Risk of 50 % = 40.000 euro at risk
To sum up, I need a 6.25 lower investment amount to achieve the same result. Basically, what I can accomplish with €100.000 is the same as with €625.000. From a risk management perspective, I need to risk 3 times less money to reach the same goal.
RISK PROFIT AMOUNT TO INVEST
150.000 40.000 500.000
40.000 40.000 80.000
Thus, a 6.25 times lower investment figure with a potential yield of 3.75 times less money at play is obviously a more attractive approach.
So what is the best course of action to take with these instruments? Should you put everything into mutual funds and stay disciplined for a period of ten to fifteen years to reach your goals? Or is it preferred to utilize managed account and reach goals much faster? This is not a final answer nor is it something that can be answered easily on an investor-to-investor basis. Rather, I would suggest a diversification that suits every investor individually based on his or her respective needs – I think there is latitude to reach the rewards and benefits of both options.
Any decision is better then no decision, and still we have the biggest amounts of the capital deposited in the bank because it is not easy to decide what to do. But if we plan our holidays we should plan our finance as well.
ABOUT THE AUTHOR: Ismar Zembo is a trader – strategy developer.