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Ways to Improve Investment Return

Nobody wants to be–or thinks they are–average.

When it comes down to it, I think that’s the only reason that low-cost passive investing isn’t enthusiastically used by every investor out there. People have a tendency to believe that they–or somebody acting on their behalf–will be able to outperform the market, whether by earning a greater return or by matching the market’s return while incurring less volatility.

However, with every transaction that occurs in the stock market, two things are true:

  1. One of the two parties is buying an investment that will underperform (or selling an investment that will outperform) and is thereby decreasing his total return relative to the market, and
  2. The total return by the group (that is, both investors considered together) is decreased by an amount equal to the transaction costs incurred.

Most books/articles about investing tend to focus on point #1 above and how to make sure you’re not the one getting the short end of the stick, so to speak.

Truth be told, I have yet to see anything that convinces me that an individual investor has any advantage whatsoever over the institutional investors who are likely to be on the other end of most transactions.

As a result, I find myself more interested in point #2 and what we can do to improve the total return earned by investors as a group. It seems to me that it would be beneficial for our society as a whole to spend more time discussing this topic and a great deal less time discussing the first.

How we can improve our total performance:

Cut costs! Common sense would indicate that, as a group, the best return we can possibly hope for is the return earned by the assets in which we’re invested. So we might as well seek to minimize costs and come as close as possible to earning a return equal to that of the market, right?

A few ways we can do that:

As far as I can tell, that’s it. Anyone have any other ideas?

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Comments

  1. Yes. Simple is good. We need to keep hearing this message.

    Find excitement anywhere else (just about) other than with your money.

    Nice reminder.

  2. You’ve hit the nail on the head, @Mike – this is the way to build your savings/investments slowly and steadily. However, as you point out, it’s not sexy to be average. I think it’s eTrade who has a commercial to that effect “who wants to be average?” Well, average is far better than paying extra and then coming out below average, in my opinion.

    I’ll add to your list: pay as little in taxes as you can. Have a Roth IRA and fund it to the max if you can. Make sure to take advantage of taxable (non-IRA or other deferred) accounts in order to get the capital gains rates on your gains, and (heaven forbid) if you have losses make that available to offset earned income.

    Great post!

    jb

  3. Neal: I like that you added “almost” anywhere else. 🙂

    Jim: “Who wants to be average” is right. The argument against average is very seductive. And thank you for adding the point about minimizing taxes.

  4. Cutting costs is the single ingredient often overlooked by investors.

    There is evidence that individual investors – and especially those who trade more frequently – consistently under-perform the market averages. That makes them no better than active fund managers.

    Despite the evidence, the idea of passive investing will never overtake active investing. There are just too many salespeople pushing mutual funds, or stockbrokers pushing individual stocks – so they can earn commissions. The needs of the investor come last on Wall Street.

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