If you're like me, every now and then one of your friends takes note of your Foolish savvy and asks you something like: "How can I beat the market without doing all that work? Isn't there something I can just buy and forget about for 30 years?"
If your friends have a sizable amount of money to invest -- say $100,000 or more -- then they might be able to open up a separately managed account via a broker and let a pro do the stock picking -- for a fee. But these conversations often come up in the context of an IRA -- where there may be a lot of investment choices, but the balance isn't big enough to qualify for professional management. The usual recommendations here are blue-chip stocks and active mutual funds. Is either a good choice?
"Blue chip" stocks -- the stocks of large, established companies -- were long touted as great investments for "widows and orphans," who weren't expected to manage their money actively. And historically speaking, some blue chips have been great investments. Companies like General Electric (NYSE: GE ) and Johnson & Johnson (NYSE: JNJ ) have been rewarding shareholders with solid growth and strong dividends for decades. But as hedge fund manager Mohnish Pabrai points out in his recent book Mosaic: Perspectives on Investing, even blue chips don't last forever.
The average Fortune 500 company has a life expectancy of 40-50 years, and given that it can take 25 years or more for a new company to grow to Fortune 500 size, many so-called blue chips cease to exist less than 20 years after they make the list! Size is no guarantee of longevity -- just ask all those Enron shareholders. And even among more established firms, times and businesses change. I'm sure that most of the investors who bought Ford (NYSE: F ) 15 or 20 years ago didn't foresee a time when the stock would be trading in single digits and the company desperately clinging to life.
Actively managed funds
Actively managed mutual funds supposedly provide access to some of the best managers and analysts on Wall Street to anyone with a few thousand dollars to invest, for a reasonable annual fee. With all that talent, no-fuss high performance should be ensured, right?
As we Fools know, there are a few problems with this scenario. Only about a fifth of actively managed funds manage to beat the market in any given year. The sheer size of most funds makes it hard for them to take concentrated positions in fast-growing stocks, and a lot of them end up behaving more or less like index funds -- except that the total fees on an actively managed equity fund can be several times what you'd pay to invest in an index fund. Worse, when the fund company changes managers -- and they will, sometimes every two or three years -- the fund itself can change dramatically. A passive investor who had bought Fidelity Magellan back in the Peter Lynch days would be very surprised -- and not in a good way -- by the fund's performance and behavior over the last dozen years or so.
Index it, Fool
In the end, if you want to beat the market over the long term, you'll need to do some work. Happily, though, matching the market's performance is easier than ever, with the wide variety of low-cost index funds and ETFs available. And if your friend is still determined to beat the market, the Fool's School is always open. Better yet, suggest a free trial of Motley Fool Champion Funds. Shannon Zimmerman and his team at Champion Funds are dedicated to sorting through the universe of actively managed funds and identifying the best bets for exceptional performance over time.