Avoid Investing March-Madness Style
By Dan Greenshields, president of ShareBuilder Securities Corporation, a subsidiary of ING
NEW YORK (TheStreet) -- Chances are your NCAA tournament bracket is already busted. Every year during March Madness, most of us learn the same lesson -- we're terrible at picking winners.
West Virginia's Da'Sean Butler attempts a shot against Kentucky during the NCAA East Regional final. |
Yet when it comes to investing, many of us employ the same losing strategy -- trying to pick winning investments in hopes of achieving big gains. And just like in the tournament, one big upset can ruin an entire bracket -- or portfolio.
Fortunately, it doesn't have to be that way. Imagine if you could win your NCAA pool by simply betting that the eventual winner would be no worse than an eight-seed in the tournament. History would be on your side -- no team with a seed worse than eight has ever won the tournament.
You can make a similar proposition in the investment world simply by committing to regular investments in broad vehicles that cover wide swaths of the market. You don't need to roll the dice and put all your money on the top seed or a sleeper pick. It may not have the cachet of riding a Cinderella team -- or particular investment -- to glory, but it's the easiest way to secure the modest annual returns that can add up to long-term wealth.
Achieving average returns can work. Consider an
S&P 500
-tracking index mutual fund or
. According to Ibbotson calculations, an investor who put $10,000 in such a fund, which diversified his or her investments, at the beginning of 2003 would have had about -- without adjusting for mutual fund fees -- $14,450 at the end of 2009 -- a 5.4% annual total return during a six year period, which included a financial crisis.
Certainly, past performance is no guarantee of future results and a fund's prospectus should be carefully reviewed prior to investing. With a longer horizon, if he or she had invested the same $10,000 at the beginning of 1990, his holdings would have increased nearly five-fold in value with an annual total return of 8.2%.
Of course, not everyone has $10,000 to invest in the stock market. Assuming you're working toward a long-term goal, investing even small amounts regularly can be beneficial. If our hypothetical investor had invested just $100 each month into an S&P 500 index fund starting in January 1990, according to Ibbotson, he'd have about $49,000 at the beginning of 2010, a return of 5.7% even with the extreme market volatility.
Many investors, however, can't resist the prospect of achieving triple-digit returns by hand-picking hot stocks on their own. Unfortunately, most of these gamblers come up empty.
Even investment pros have a tough time beating the market. From 2004 to 2008, the S&P 500 index outperformed more than 70% of actively managed large-cap funds. The results for the previous five-year cycle were similar, according to Standard & Poor's.
In addition to diversification, funds that track broadly based indices of American, foreign, or even value-oriented stocks offer investors other benefits, like lower fees. That too can add up to bigger returns.
Consider two funds -- one an index fund tracking the S&P 500 with lower fees and the other an actively managed fund with higher fees. If both funds posted similar annual returns, the shareholder in the index fund would end up paying less in fees than his counterpart in the actively managed fund. And the difference in total returns would only grow with time. In fact, the actively managed fund would have to outperform the index just to deliver an equal return to shareholders. That can be difficult to do.
Investors are beginning to understand these realities -- and consequently are becoming more self-directed in their investment strategies. Nowadays, according to
a recent survey by ShareBuilder
from ING Direct and Harris Interactive, investors are relying more on financial blogs and Web sites than brokers or financial advisors for investing advice.
Unlike in basketball, Americans need not have deep pockets or an outsized knowledge of individual stocks in order to become successful investors. Indeed, a simple strategy of automatic investing and achieving average returns can turn small sums into sizable gains -- and ward off a portfolio-busting upset.
-- Written by Dan Greenshields in New York