Accepting market return
Average. Not the most sought-after adjective. Above-average is the goal after all, right?
Yet embracing the average when comes to matching 'market return' is an important step in long-term investing. 'Market return' sounds like a metric that's somewhat easy to best, kind of like 'median household income' or 'typical mileage'. However, when selecting a long-term investment, it turns out that 'achieving market return' - especially over time - is a well above-average result. A few of the challenges to selecting a mutual fund which will beat market returns over time:
1) Identifying talent in advance. Warren Buffett has been the greatest mutual fund manager in the last century. A $1K investment in 1964 is worth more than $10M today. But, in 1964, Warren Buffett was running a textile mill in New England. Precious few would have risked even a fraction of $1K on the 1964 Buffett enterprise.
2) Transaction costs. Mutual fund managers often move in and out of investments in an attempt to time the market. Buying low and selling high can generate returns higher than market returns, but this turnover generates capital gains and other transactions costs. Those costs are borne by the investor and drag the return lower.
3) Management costs. Fund managers and their team of analysts get compensated for the stock picking acumen. Even when their picks don't beat the market. These costs are borne by the investor and drag the return lower.
4) Size. As mutual funds perform well, they garner investor attention and a glut of money. As the fund grows in size, it loses the nimble characteristic that allowed the manager to quickly take large positions in specific securities, making the fund slower to react to news and likely less likely to reap the rewards of any emerging situation.
With all these factors (and more) hampering mutual fund managers' ability to beat market return, you may be asking "Well, where can I get market return?". The answer is an index fund.
In an index fund, your manager doesn't select specific stocks. He selects every stock in the index. He does this because he is not trying to beat the market; his sole aim is to match the market. This addresses the challenges above in the following ways:
1) Identifying talent in advance. No need. Unlike the earlier manager who has to identify and purchase stocks that have a big upside, it takes no talent to buy each stock in the index.
2) Transaction costs. Nearly none. Trades are only done to match the characteristics of the index, which change in a glacial fashion.
3) Management costs. Tiny. No hefty compensation is needed since talent isn't a prerequisite for the index manager job.
4) Size. Index funds are huge, but they don't need to be nimble since the makeup of indexes change so infrequently.
So, if you want to try to beat the average, there are plenty in the mutual fund industry who will help you try. If you can embrace being average, history shows that you'll end up well ahead of the supposedly above-average crowd.
The link below describes how tough consistently beating the market can be.