Picking a good investment

When you’re making any purchasing decision, you make a judgement about whether you believe you’re getting value for money.  Along with price, other things that may come into the calculation include convenience, great service or in the case of luxury goods, the perceived effect on your social status.

But when it comes to money management, the one factor that should not sway your decision is the promise of “great investment returns”.  As alluring as this sounds, we know that this is a very difficult promise to keep and the evidence will tell you this if you check the return that your money manager delivers (i.e. stockbroker, fund manager or financial adviser).

Measuring investment performance

If you do get a promise of great investment returns, your portfolio performance should be measured against the market return.  If your adviser is picking Aussie shares for your portfolio, then you should know if they are getting a better return than the market itself.  Why?  Because you can buy the market yourself at a much lower cost!

Don’t get me wrong, these stock-picking professionals are trying to beat the market.  It’s just that it is really hard to do.  You don’t want to pay extra if the result is more due to chance than skill.  And that is what the evidence from Karaban & Maguire (2011) is telling us:

The S&P/ASX 200 Accumulation Index has outperformed approximately 70% of active Australian equity general funds over the last five years, increasing to approximately 77% over the last year (mid year 2011).  At least 69% of active international equity funds underperformed relative to the benchmark over every time horizon. Over the last year, the index has outperformed approximately 80% of actively managed international equity funds.

So if the odds of beating the market are that bad, why would you pay more for the promise of better returns?

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