Let’s say you have good friend Ashish, who is an “excellent and ethical” businessman. Ashish wants you to invest some money in his business. He will have to offer you a better rate of return than the bank rate to get you interested in investing in his business. If the bank paid you more, you may not be keen on investing in Ashish’s business as it is risker than the bank and you would like to be compensated for the risk. This applies to market in general as well, in the long run equities provide a better rate of return than the bank rate. Pl remember the operative word is “in the long run”, this means over a 5 year period.
The way to get exposure to the “market” is to purchase index funds or index ETF’s. Index return indicates the average return realized if one invested in all the securities that are listed in the Index. Typically index represents over 85% of the market, in terms of market capitalization, hence index can be considered as a good proxy for the market.
It’s important that we realize that, average market return is not the return is not the return generated by an “average” investor, but is the average return on capital. Let’s not forget that capital is concentrated in the hands of a few wealthy people.
Most retail investors underperform the index due to “sub-optimal” portfolio selection, or decisions made in a state of fear or euphoria. Most professionals (read mutual fund managers) fail to beat the index either due to constraints, too much trading, also due to fees charged to the investor. You can read more in the article “good guys don’t always win..”
We are not contending that it is not possible to beat the market, but we believe that it is very difficult to do this consistently. Warrant Buffet, one of the most successful investors, said in his 2013 report (on page 20), about his plans for wealth as stated in his will, “My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors – whether pension funds, institutions or individuals – who employ high-fee managers.”
For most of us who want to generate wealth, the best way is to invest funds that are available for a long term into Index funds, it is even better if we can invest on a regular basis. For those who choose to hire wealth managers, pl make sure that you are compensating your wealth manager for beating the average. (You should be looking at risk and fee adjusted return, pl stay tuned we will publish an article regarding this).
In summary, people who are able to realize the market average return by investing in the market index are going to generate significant amount of wealth and will do much better than most.
Pl remember: The average will generate wealth for you….