Hedge funds are sexy and mutual funds are boring. But in the world of investing, I’d choose the latter every time.
In fact, while most hedge fund managers and investors are actively trying to outguess the market, I’d go as boring and passive as possible and buy low-cost index funds and invest for the long term.
I’ve written here before comparing these fund types in my story, Vanguard vs Hedge Funds (Guess Who Wins), but my convictions on the boring-but-beautiful index funds recently became stronger when I saw a story on massive redemptions from hedge funds.
In June of this year, investors pulled more than $20 billion out of hedge funds, which is the most outflows since 2009, with exception of year-end outflows.
And why would investors pull assets from hedge funds in such large numbers? Two words: poor performance.
Although it’s still too soon to know exactly where the hedge fund assets went, I’ll guess some of the investors are sitting on their cash wondering where to put it. My humble suggestion is for them to buy mutual funds.
And I’ll even offer some reasons that mutual funds are better than hedge funds:
Mutual Funds Are More Accessible Than Hedge Funds
Whether you want to be a cheap rich person like Warren Buffett or you want to get rich by purchasing shares of top investments, mutual funds are the most accessible means of building wealth.
Hedge funds often require that investors have a net worth of $1 million or more and they may require high minimum purchases. So if you can afford the high minimums of hedge funds, you can easily cross the hurdle of the low required minimum purchases of mutual funds and join the ranks of the smart investor community.
Even us everyday investors can afford the $100 minimum initial purchase of an outstanding index fund like Schwab S&P 500 Index Fund (MUTF:SWPPX). And if you want to park larger sums of money in a mutual fund, you can go for the Admiral share class of a top Vanguard fund like Vanguard Total Stock Market Index Fund (MUTF:VTSAX), which you can get for $10,000.
The Expenses of Mutual Funds Are Lower Than Hedge Funds
If you want to keep more of your money, spend less of it. This timeless piece of personal finance wisdom applies directly to investments.
Hedge funds typically have expenses of 2% or more and they often take a cut of profits of up to 20%. Many of Vanguard’s best funds have expense ratios that are 10 times lower than that — around 0.2% or less.
Vanguard’s flagship index fund, Vanguard 500 Index (MUTF:VFINX), has an expense ratio of just 0.16%, or $16 annually for every $10,000 invested. And returning to the accessible point, the minimum initial purchase of VFINX is $3,000.
If you can afford a higher initial investment amount, $10,000 will get you the Admiral Shares of the fund, which has a rock bottom expense ratio of 0.05%.
Mutual Funds Can Get You Higher Returns
The likely culprit in the big outflows from hedge funds in 2016 is poor returns. Funds of hedge funds had net returns of -1.49% in the first five months of the year, according to Evestment.com.
To be fair, most hedge funds are designed to perform better than their conventional mutual fund counterparts in down markets; hence the term hedge.
But mutual funds can also hedge, and they can outperform major market indices in turbulent times. Consider one such fund, Hussman Strategic Total Return (MUTF:HSTRX), which I highlighted in another story I wrote called Best Mutual Funds That Act Like Hedge Funds.
Hussman returned 6.3% for 2008, during the worst of that bear market, when the S&P 500 Index had a -37% return. Year-to-date 2016 HSTRX is up 11.8%, while the S&P is up 6.8%.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, South Carolina. Under no circumstances does this information represent a recommendation to buy or sell securities.