| The investment markets as a whole are very | | | | If the end investor utilizes an adviser, as indicated |
| humbling. They have an uncanny knack of toying | | | | in the above paragraph, and the adviser adds |
| with those who believe they have a system to | | | | himself a 1% portfolio management fee, that's |
| beat them, until they get bored with the toying | | | | 13% just to break even. Most people don't just |
| and promptly destroy these so-called experts | | | | want to break even, they're hiring this guy |
| financially without a second thought. Their fate is | | | | because they want to outperform. If said |
| often analogous to a mouse that had the | | | | investors are somewhat grounded in their |
| misfortune of falling into the clutches of a cat. | | | | expectations, and only want 1% above the |
| Nonetheless, we Americans have a nasty habit of | | | | markets, the actual number that must be |
| neglecting the mounds and mounds of available | | | | achieved is now up to 14%! If you haven't |
| data showing that, on average, it's difficult to beat | | | | thrown up your arms in surrender yet, let me add |
| the averages, so we continue, often to our own | | | | some other sobering numbers. If this active |
| peril, to search for that guru active mutual fund | | | | manager's mutual fund is being held in a |
| manager that we believe can do what many | | | | non-qualified account, taxes, both income and/or |
| before him have failed to do, that is, consistently | | | | capital gains taxes must be factored in, and if the |
| beat the averages. | | | | fund is being held in a 401k plan, there's expenses |
| What I'm about to show you is that the chore is | | | | involved for plan custody, and platform fees |
| much more complex than simply "one upping" the | | | | among possibly many others. |
| averages. Most people focus only on the obstacle | | | | Your best bet is to try not to anger the |
| of outperformance, when there is another | | | | "investment gods" by setting far fetched goals |
| obstacle that must also be cleared, and this | | | | for yourself, which is why I believe in utilizing |
| second obstacle is two-fold. The obstacle itself is | | | | Exchange Traded Funds (ETFs), which invest in |
| called "internal expenses," and the two fold | | | | indexes such as the Russell 3000 Index. The |
| challenge of these expenses is that the active | | | | internal expenses of an ETF that mimics the |
| manager must beat the market factoring in the | | | | performance of the Russell 3000 index is around |
| costs involved for him to do the job (including the | | | | 0.20%, if management fees are added on top of |
| costs of trading in and out of the markets, and | | | | that it comes out to 1.20-1.45%, depending on the |
| paying the firm he works for and himself an | | | | amount of money under management. Trading |
| adequate compensation), AND he must beat it by | | | | costs are either $9-$18 depending again on the |
| enough that it makes the end users, the fund | | | | amount of money managed and you should really |
| investors, enough above the average to make it | | | | only trade once per quarter on average |
| worth their while to pay the active manager to | | | | maximum (in both cases, the more money you |
| make them money while he's beating the market | | | | have, the lower the fees.) I think you'll agree that |
| averages. | | | | a 1.50% outperformance is much easier to attain |
| As we all know from hearing and reading the | | | | than a 4% outperformance. Of course, if you do |
| stats a zillion times, somewhere around 80% of | | | | it yourself because you already know how to |
| the experts fail to beat the averages on a | | | | properly allocate the assets among various |
| consistent basis. I'm going to go out on a limb, and | | | | non-correlating asset classes, you can avoid the |
| guess that excessive internal expenses are able | | | | management fees and save yourself some more |
| to put the kibosh on most of the remaining 20%. | | | | money. Knowing how to properly allocate the |
| To add yet another possible obstacle, if an | | | | assets is how investment advisers earn their |
| investor hires an investment adviser to manage | | | | keep, because if the assets are properly allocated |
| his money, and the adviser purchases funds in his | | | | you can attain outperformance over the |
| strategy utilizing a "manager of managers" style | | | | averages (known as "alpha" in investment |
| of investing, and the adviser charges 1% for his | | | | vernacular) by that proper allocation. In other |
| services, that is still another layer of expenses | | | | words, even though you're investing in the |
| that must be overcome before the investor | | | | indexes, which are market averages, the whole is |
| makes a profit. | | | | greater than the sum of it's parts merely by |
| To put some numbers to what I just described, | | | | proper allocation. |
| let's take a hypothetical active mutual fund | | | | In conclusion, there just might be a guru out there |
| manager trying to outperform say, the S&P | | | | that can do the difficult and outperform the |
| 500. We'll say for the sake of this example that | | | | markets, but until you find him, he also better be |
| the S&P finishes the year with a 10% annual | | | | a retail money manager that doesn't want only |
| return for the given year of our example (yeah, I | | | | large institutional sums of money that the |
| know 10% is a beautiful, yet far fetched return | | | | average American is not likely to have, what are |
| over the tumultuous markets of the past few | | | | you going to do until then? We suggest sticking to |
| years, but it's easy to work with so I'm going to | | | | index investing and proper allocation. As I said in |
| stick with it.) If the active manager charges | | | | the beginning, using the outperformance number |
| 1.50% for his hard work, he now has to earn | | | | alone, sans fees and expenses, 80% of active |
| over 11.50% just to break even with the market. | | | | managers fail. I don't know about you, but when |
| We'll say he incurs another expense of roughly | | | | the weatherman says there is an 80% chance of |
| .50% in trading costs (hey, the brokers who | | | | rain, I usually take along an umbrella to wherever |
| execute his trades have to pay their bills to ya | | | | I'm going. |
| know), now we're up to 12% just to break even. | | | | |