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Here’s a historical fact:  Mutual funds, hedge funds, and other structured products have reduced the odds for investors to achieve optimal performance.

That’s because the vast majority of investment products have consistently underperformed their corresponding benchmark index.

Ironically, improving performance by reducing exposure to investment products is often a difficult step for investors to take. The media, Wall Street, and even our own instincts tell us that intelligent experts can beat the markets. Unfortunately, the data clearly shows that very few investors ever achieve actual outperformance.

There are numerous reasons for this, but the management and sales expenses related to investment products is likely the most common problem.

To illustrate an especially eye-opening example, here is a graph from  FundReference.com  that shows the difference in performance of the S&P 500 index when an average ETF expense is charged and when a hedge fund expense is charged – a $500,000 difference entirely based on expense!

 

Hedge 2 and 20 SP-500

 

As this chart so clearly illustrates, there is a great wealth opportunity in the hedge fund product industry. It’s just not the one that most hedge fund investors think it is.

By the way, there’s only been one year in the past 10 that the average hedge fund beat the S&P 500. Yet, they are one of the most popular investment products in the financial industry today.

So, what’s an investor to do?

The first step is to stop buying Wall Street’s most powerful pitch – the illusion outperformance.

Instead of chasing the Street’s hottest products; consider this - if you simply performed inline with the major indexes over the past decade you would have outperformed over 87% of the investment product industry.

In other words, you would have beaten the Street, by simply not playing their game.

Today, the easiest way to checkout of the product game is to use ETF’s.

Index-based ETF’s help to create:

  1. Portfolios that tend to be much easier to properly diversify.  There’s no need to wonder what the different product managers are changing, and how that impacts the risk and balance of the whole portfolio.
  2. Portfolios that are usually less expensive.  On average an index costs one tenth the average equity fund.
  3. Portfolios that tend to be much easier to manage from a tax perspective.  There’s rarely phantom capital gains, and positions can be easily held, or sold with original basis.
  4. Portfolios that are fully liquid – there’s no lock up periods, or back-end charges.
  5. Portfolios that are typically easier for investors to understand, monitor, and control.
  6. Portfolios that are easily portable – there’s never any concern about proprietary nonsense, surrender charges, or penalties.
  7. Past performance doesn’t assure future success, but index-based ETFs have historically outperformed comparative investment products.

Index-based ETF’s have fortunately gained in popularity in recent years, but the vast majority of investors still have portfolios dominated by expensive mutual funds and structured investment products.

In fact, baby boomers have the lowest exposure to ETFs of any age group at only 12% of their holdings.

The transition away from expensive products will likely be especially difficult for boomers since the advisors they work with are often the primary source of the problem.

But ultimately, when investors sit down with an expert who can show them ”exactly” how much they’re paying, and compare their portfolio components to the corresponding benchmark index; the result is almost always the same.

They’re paying much more than they realized, and are at the same time underperforming the benchmarks.

There are numerous aspects to investing that are not at all obvious or easy.  However, there are some basic steps to optimizing a portfolio that all investors should likely take, and removing most of the financial products from their portfolio is likely one of the easiest and most impactful steps of them all.