|»5 Minute Wrap Up by Equitymaster|
On This Day - 13 AUGUST 2014
A low risk strategy to earn 12-15% per annum
In this issue:
Most of us would be tempted to invest with the fund manager in anticipation of higher returns, right? However, the best investor of all times, Warren Buffett, who has managed to create US$65 bn of wealth through active investing, would choose option two. Surprised? Though being an active investor, Warren Buffett is a big fan of index funds. Hence, this does not bemuse us that much.
In fact, he has candidly admitted in his letter to shareholders that his legacy wealth should be passively mimicked. Now, you may wonder why a person who has created so much wealth through active investing is actually propagating indexing.
The reason is simple we reckon. Over a longer time period it becomes virtually impossible to beat markets. And the Oracle of Omaha recognizes this fact pretty well. Fathom this. A study conducted over the period 1996 to 2008 of the US mutual funds industry has showed startling results. Out of the 1,825 mutual fund managers that oversaw various schemes, only 25% lasted more than 5 years. And only 195 lasted a decade.
The fact that only a handful of managers managed to survive a decade signifies their underperformance. And the power of indexing. If over a 10 year period, only 11% of the managers survive, it speaks for itself how difficult outperforming benchmarks can be. Mind you, one also has to pay a management fee for this underperformance!
True, that even an index fund would have management fee associated with it. As a result, the true investor return would be slightly lower. Hence, the emphasis of investing in a low cost index fund. This would ensure that actual benchmark returns are partially mimicked.
Remember, it is not that money is made only by beating the index. In fact, when a fund manager tries to do the same he could perhaps take unnecessary risks and ultimately lose some. This is where index funds provide value. You are at least assured of the benchmark return which in the case of Sensex could be in the region of 12-15%.
So, does this mean that one should completely ignore investing with a fund manager and just index?
Well, not really. In fact, the decision to actively invest entails considerable due diligence. Historical track record of the fund manager, fee structure and research capabilities of the firm are some factors that investors should watch out for. Active investing would make sense if due diligence results turn out to be favourable. Else investors would be better off in indexing .
Do you believe low cost index funds can generate better returns than mutual funds over the long term?
Let us know in the Equitymaster Club or share your comments below.
Will this be enough to tackle the ponzi menace in India? While it may not completely eradicate ponzi schemes from taking root in India, with these much stronger investigation powers that the regulator will now posses, it will nonetheless go a long way in acting as a strong deterrent.
And what are the policymakers doing to take it out of its current funk? Well, they are trying things like increasing consumption taxes and are creating their own version of quantitative easing. We are not surprised that the move is hardly working. Simply because it is the purchasing power that decides the fate of an economy and not things like money printing and consumption taxes. And for the purchasing power to increase, Japan will have to undertake some major structural reforms. It will have to unleash an improvement in both capital and human productivity like never before. And unless it does this, there's very little chance of the Japanese economy really taking huge strides forward.
NW^= North West, NE$= North East, SP# = South Peninsula
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