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The Indomitable Investor: Why a Few Succeed in the Stock Market When Everyone Else Fails by Steven M. Sears

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Active versus Passive Fund Management

The discipline of constantly questioning how your money is managed applies to all areas of your financial life. A healthy skepticism will serve you well, especially when picking funds or ETFs. Most investors with account balances under $100,000 should probably only buy ETFs or mutual funds that charge low management fees. If you must choose actively managed mutual funds, look at more than one year’s performance. Compare fund fees. At minimum, see how the fund fared over five years. Ideally, review a fund’s performance over its entire lifecycle. If the fund changed managers, look at how each manager performed. A lot of changes might indicate trouble at the fund. It is probably a good idea to initially avoid mutual fund rankings like Morningstar’s star system. Do the work yourself. Develop your own opinion, and then compare it to Morningstar or other companies that rate funds.

The idea of owning indexes or ETFs that track the market is scary for many investors. Indexes rise and fall with the market. Actively managed funds have someone at the helm who hopefully buys low and sells high. Yet, some two-thirds of all mutual fund managers fail to beat their benchmarks.

Standard & Poor’s put the question to the test. The company found that 71.9 percent of actively managed, large-capitalization mutual funds failed to outperform the S&P 500 from 2004 to 2008. The number was even higher for the S&P MidCap 400; 79.1 percent of mid-capitalization funds failed ...

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