Saving money is certainly a smart move, but investing money (carefully) is even smarter. Over time, long-term investments can pay surprisingly large dividends, and if you’re not investing your savings, your bank is doing it instead…and keeping the vast majority of the winnings. Don’t let anyone tell you that investing is too complicated for regular people; there are lots of easy, automatic ways to invest (see SmartyPig and ShareBuilder) and that are designed specifically for people like you who have better things to do than feverishly checking stock quotes on a daily basis.
One of the most common easy, automatic investments is an index fund. Index funds are designed to follow and reflect an entire market, like the US domestic stock market for example. Index funds do not attempt to pick “good” companies or companies with potential. Rather than playing favorites, they buy a sampling of every company in perfect proportion to their respective sizes. As a result, index funds own large stakes in large companies, and small amounts of a multitude of small companies. As these companies perform well or poorly, the fund aggregates their total performance.
Owners of an index fund do not have to deal with buying individual stocks, doing intensive research, or making difficult decisions. The fund manager maintains the fund, and because index funds do not pick winners and losers, the fund manager doesn’t really have any truly intensive research to do or truly difficult decisions to make. Because of this, the management fees for these funds are often very low, which offers greater returns for investors like you.
Advocates of index funds will argue that attempting to pick winners and losers in the stock market is an extremely difficult game that very few can win. Actively managed mutual funds — the opposite of index funds — try to identify and invest in companies that will perform well in the future. The research needed to make such difficult decisions takes time and talent, and investors must pay for both without any guarantee that it will be worth the cost. The majority of these actively managed mutual funds end up performing worse than the overall market, meaning the managers who attempted to pick winning companies often end up picking poorly. The worst part is, whether an actively managed mutual fund performs well, average or poor, investors must pay the fund managers for their efforts.
Actively Managed Mutual Funds
While it is true that most actively managed mutual funds cost more and earn less than index funds, there are mutual funds that beat the overall market by correctly choosing winning companies. Although they’re a minority, there are mutual funds that have proven over many years to have the knack to find winning companies, buy and sell them at the right times, and create profits for investors like you. Although there are rating systems designed to identify exceptional mutual funds, they are still fairly difficult to find. And, as funds have “hot streaks” and “slumps,” the truly worthy mutual funds will vary over time. Because of this reality, almost every investment research document ends with a disclaimer stating that “past results are not an indication of future performance.”
Passive Or Active Investing?
The majority of personal investment research is the search for the few mutual funds that are truly worth their added costs. To find and invest in these mutual funds, you’ll not only need to pay the fund manager, you might even need a third-party financial adviser just to help you separate the worthy mutual funds from the rest. This creates quite the dilemma for investors: Should they invest in the whole market without trying to pick winning and losing companies? Should they search for mutual funds that correctly pick the true winners and losers? Is the added cost of “active management” worth it in the end? Traditional financial advice would tell you that you have two options: Buy index funds and get out of the game of picking winners and losers, or buy actively managed mutual funds and pay fund managers to do research, make decisions and try to earn their keep by performing better than their index fund counterparts.
A Third Option: Crowdsource Your Investment Research And Skip Management Fees
But, there may be a third option: you may be able to get that careful research and industry-specific financial expertise without ever having to pay for it. Crowdsourcing has become a great method for leveraging the collective expertise of large groups of people. Individuals often have very specific areas of knowledge, and if their deep knowledge in a certain area can be combined with the specialized knowledge of others, it can result in a broad array of knowledge that also has great depth and detail.
In terms of investing, those who study specific sectors of the market could combine their knowledge (and their resulting stock picks) with experts in other industries to create a broad portfolio of carefully-researched companies. The best part is that you could leverage their collective expertise instead of padding the pockets of a fund manager who is likely already making quite a bit of money…even if his fund isn’t really performing any better than the market itself.
Motley Fool CAPS is an online community where investment researchers share the fruits of their labor by providing their stock picks. CAPS keeps a historic record of the picks made by CAPS users, and they offer the stock picking data in many different forms. As stated before, “past results are not an indication of future performance,” but it’s hard to ignore individuals who seem to always pick winning stocks. There’s no guarantee, but there’s also no cost — which is vastly different than the hefty fees of a fund manager.
If you’re looking to invest actively, but lack the insight or the time to research companies with high potential, consider crowdsourcing your stock picks, and leveraging the proven expertise of your peers instead of paying handsomely for similar skills from a fund manager.
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