Want to Outperform 90% of Hedge Fund Managers? Buy and Hold This Asset Forever

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Written by Andrew Button at The Motley Fool Canada

Did you know that it’s actually very easy to outperform big-name professional investors you read about in the news? That might sound like an outrageous claim, but it’s proven.

A few years ago, Warren Buffett bet a top hedge fund manager that one simple asset class would outperform the hedge fund industry over 10 years. Buffett won the bet. Not only did he win, but he won by a fairly wide margin! The crazy part is, this asset class is extremely well known and is available to even “know-nothing” mom-and-pop investors.

In this article, I will explore the one asset class that regular, everyday investors like you can use to outperform billionaire hedge fund managers.

Broad market index funds

Broad market index funds are funds that invests in the entire stock market, hence the word broad. They are investing “broadly” across the entire universe of stocks. These funds cost next to nothing (0.04% fees are commonplace), they offer dividend income, and they outperform 95% of hedge fund managers over 20-year periods. The craziest part about these funds is that you don’t even need to do much research to invest profitably in them. The extreme diversification present in these funds reduces the level of risk so much that you don’t even need to think about the individual companies they invest in.

Retail investors who have bought broad market index funds diligently over the years have outperformed most professional investors. Consider Vanguard S&P 500 Index Fund (TSX:VFV), for example. It’s a TSX-listed fund that holds U.S. stocks. The fund invests in the S&P 500 — the 500 largest U.S. companies by market cap. It charges a mere 0.08% management fee.

Over the years, it has delivered an average return of about 11% per year. That’s far better than what your average hedge fund returns after fees and literally any investor can buy it. All you need is a brokerage account, which you can set up nearly instantly through your bank — and you can buy index funds and outperform the professionals.

What about the companies that manage index funds?

As we’ve seen, index funds tend to outperform most professional investors over the long haul. You could just stop reading here and invest in such funds for the rest of your life. This is essentially what college finance textbooks tell you to do.

However, investing in individual stocks is arguably a lot more fun than buying index funds. True, it’s riskier, but it also provides the gratification of supporting a company you believe in. That thrill is not so easily obtained with index funds.

If you want to invest in individual stocks, a great place to start would be to invest in the companies that sell index funds: asset managers and banks. The advantages of index funds outlined in this article are very well known. As a result, the index fund industry is booming, and creating big profits for the companies that operate such funds.

Consider Bank of Montreal (TSX:BMO) for example. It’s a Canadian bank that operates a number of its own funds. It also offers Blackrock index funds through a partnership with that company.

Bank of Montreal’s stock has a lot of things going for it. It’s cheap, trading at just nine times earnings and 1.1 times book value. It has income potential, with a 5.4% dividend yield and a 48% payout ratio. Finally, the company is investing in expansion, having recently purchased the U.S. bank Bank of the West from BNP Paribas. Over the years, BMO has outperformed the average TSX bank by growing faster than its peers. Its stock might be an interesting indirect way to invest in the rise of index funds today.

The post Want to Outperform 90% of Hedge Fund Managers? Buy and Hold This Asset Forever appeared first on The Motley Fool Canada.

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Fool contributor Andrew Button has positions in Vanguard S&P 500 ETF and Bank of Montreal. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.