Tips for Taking the Right Vehicles to the Stock Market

You should always focus on net returns. Even if you own a fund that has great absolute returns, this does you little good if you have to pay too much for them.

Before or after expenses, the issue of whether fund managers can outperform the market is part of a longstanding debate in the investment community over which is superior – passive management (indexing) or active management (buying and selling stocks in a portfolio, as mutual fund managers do).

This debate, with intensity and vitriol comparable to differences between political parties, has persisted for the 40 years that index funds have existed, and shows no signs of abating.

Indexers embrace the findings of economist Eugene Fama (winner of the Nobel Prize for economics this year) that markets are "efficient" – meaning that prices tend to reflect information that everyone in the market already has. Indexers have interpreted Fama's findings to mean that, because all known information is already priced into a stock, there are no bargain prices. The upshot of this, indexers argue, is that it's impossible to consistently identify winners and thus outperform the market.

While acknowledging the concept of market efficiency, active-management proponents argue that windows of inefficiency – instances where stocks are temporarily underpriced because it might take a while for new information to become widely known – create opportunities for adroit active managers.

If this is the case, precious few active managers are adroit and, if they are, they don't stay that way for long. Those who consistently beat their benchmarks tend to lose steam after a few years.

Picking winners is extremely difficult, but there are other reasons these managers' funds eventually founder. One is that, after acquiring a lot of investors and assuring a good income for their fund companies and themselves, managers have a tendency to become closet indexers to protect against losses that may cause investors to cash out. This more conservative approach tends to preclude the kind of high-flying returns the fund was achieving when the fund company began touting it.

And the company began touting the fund because it was doing well initially, when the manager was taking more risks but succeeding. Had such managers not succeeded early on, most investors would never have heard of these funds. So, while it looks like managers almost always tend to lose their mojo, it's because it's almost planned that way; it's a stage in the cycle of every successful (for a time) mutual fund.

A mutual fund manager's record doesn't help you if you're investing in that fund today. Too many investors chase past performance to their peril.

How can you identify mutual fund managers who are likely to do well in the next couple of years? This is an extremely difficult task that requires extensive knowledge and advanced technical tools.

Whatever tools you use to access the capital markets, there will be risks. One of the greatest types of risks you face are those you pose to yourself. Women might have an edge in this regard because in investing, pride definitely goeth before a fall. Research shows that prideful overconfidence among men leads them to mistakes from investing too aggressively – without as much regard for risk – as women have. So an investing mantra for women investors might be: Don't listen to your husband or boyfriend.

This isn't to say that women can't invest themselves broke just as easily as men; they just do it differently.

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