Do You Need a Hedge Fund?

2006-11-05

As the market continues to recover, the Dow just recently broke the 12,000 mark. But, for some the returns still have not been all that great as returns have struggled to rebound. Many have started looking outside of traditional investments in an effort to earn higher rates of return. Financial services firms have created new products to fill the desires of investors, but are they really worth it? For many the answer is no.

These hedge funds make it easy to get into more sophisticated investments. These investments may seem like an easy way to revive a flagging retirement plan. But, the risks and fees could hinder your plan rather than enhance it.

Many hedge funds are run by some of the brightest investment minds in the business. Many can churn out returns regardless of whether stock prices are rising or falling. But after adjusting for risk, the performance of these hedge funds is yet to be determined. For example, one study concluded that hedge funds can lag the market when to factor in “survivorship bias”. Survivorship Bias means that hedge fund databases that don’t include the returns of businesses that are no longer in business or are no longer reporting their results.

Unusually high fees are a part of the privilege of becoming a hedge fund owner. Many charge management fees of 1% to 2% of the total assets as well as 20% or more of the profits. If you own a fund of funds, you’ll also pay a fee to the main fund. As these fees add up, you’ll see what you thought was a great return, cut by as much as 50%. For example, if you see a gross return of 12% - a 2% management fee – 2% incentive fee – 2% fund of funds fee = a 6% net return.

When making your investment decisions, be sure to get all the details before making a purchase. In my opinion, you are better suited avoiding these funds because you could end up either paying very high fees or you’ll need incredible timing to come out ahead. All investing involves risk, but what really creates wealth is long-term investment potential of companies large and small. You don’t need any fancy strategies to accomplish your goals. You just need to invest in a nice mix of low cost stock and / or bond funds. This may not be the sexy choice, but this slow approach has three advantages: it’s cheap, unlikely to fail over time, and last but not least – despite occasional setbacks – it works!

Related Articles:
» What is Your Risk Tolerance?
» A Scientific Look At Making Bad Investments
» The Lowdown on Balanced Funds

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