mutual funds and Index funds investment - what you need to know

Warren Buffet once stated in an interview on CNBC that the average investor will get a better return on their investment by investing in an index fund versus using a professional fund manager. This is primarily because, after transaction costs and fees, actively managed funds simply can't match the performance of the average index fund.

95% of funds with winning 3-year records failed to beat the S&P 500 Index the following 3 years - Ryan Poirier, S&P Dow Jones Senior Analyst

The average compensation of a portfolio manager is right around $300,000 while portfolio managers at top-performing hedge funds can earn close to eight figures according to a recent study. Managers at actively managed funds have staff that research and select stocks of companies they believe will outperform the market in the weeks and months ahead. The buying and selling of investments cost the fund money in the form of commissions and transaction fees, something that an index fund avoids by buying and holding a matching basket of securities held by the underlying index.

In addition, active funds need to keep enough cash reserves in order to be able to purchase investments and this cash sitting on the sideline reduces the overall return of an actively managed fund.

Choose Low Cost Mutual Funds

By far, the best investment move you can make now is to invest in low-cost index funds.  In fact, excessive fees can wipe out two-thirds of your portfolio! Here's an example to illustrate the point. Let's say that the market returns 7% over 30 years. Because of the compounding effect of money, your $1 dollar investment grows to $8.12. The average actively managed fund charges you 2% per year in fees which reduces your average annual return to 5%. At this rate, your investment is now only worth $4.47.  On the other hand, the average low-cost fund charges just .25% These fees reduced your return by a whopping  55%! In other words, an investment of $10,000 would grow to $289,000 versus $121,000.

Re-Balance Your Portfolio Quarterly
Asset allocation is an important component in reducing risk in a portfolio. Over time, asset class balances can drift from the original target percentages so re-balancing at least twice a year is a good idea.

Take Full Advantage of Tax-Deferred Accounts
If you believe you will be in a lower tax bracket when you retire, a 401k tax-advantaged investment account allows your pre-tax investment dollars to grow tax-deferred until retirement. When you make withdrawals, you'll pay taxes at your then-current tax rate.

Dollar-Cost Average

Dollar-cost averaging is a simple investing strategy where the investor buys a fixed dollar amount of an investment each month regardless of the share price.  This results in a lower average per-share cost over the long term since when prices rise you are buying fewer shares and when prices fall more shares are purchased.



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