buy and hold beats a really good hedge fund??? (analysis)
If you bought stocks in 1950 (as far back as yahoo finance data goes) and simply held until today (presuming an index fund had existed then), you would have earned about 7%/year as the S&P rose from 17 to ~1100 (from jan 1950 until jan 2010). Adding in a 3%/year dividend that makes for a 10% return. If you bought stocks in jan 1960 and held until jan 2010 you would have made an average of 6%/year. Adding in a 3% dividend, thatgets us to 9%/year. From 1970 to 2010, 6.5% + 3% = 9.5%. From 1980 to 2010, 8% + 3% = 11%. From 1990, 6% + 3% = 9%.
Taking a quick look, right now we are 33% down from a recent high (the oct 2007 high). Buying at any point where the S&P was down 33% from a recent high and holding for 20/30/40 years yielded these returns:
from the dip in 1970 we have a 20 year return of 11.3% (including a 3% dividend), a 30 year return of 14.5% (inc divi), and a 40 year return (to april 2010 assuming S&P 1100 then) of 10%. From the dip in 1974 (not the bottom of the dip, but the sides of the dip when we were down 33% from the previous high) we have a 20 year return of 11.5% and a 30 year return of 12%. Etc.
The point of this introduction is this: buy and hold has yielded about 10% since 1950 and has yi8elded even better returns of ~11-12% if you buy and hold from a point when the market is significantly off a previous high.
Now, buying and holding may involve selling out of some given stock or other at some point, and you may incur some taxes on your returns here and there. Plus, you will be taxed on your dividends (at lets just say 20%, the rate that you will pay soon and previously). So lets say that the annual tax rate on your buy and hold stocks is 10% and 20% on dividends.
Now the 7% becomes more like 6.3% and the 3% dividends move to 2.4%, leaving you with a 8.7% return. Or, assuming that you buy when the market is significantly down from a previous high, more like 9-10%, after taxes. This assumes that you buy index funds with extremely low loads/fees, like SPY, which seems to have tracked the S&P almost perfectly since its inception.
So you make 9-10% from here, based only on history, and not being too optimistic, just buying SPY and sitting around. And remember, we are calculating those returns tonow, a time when the market has been in the toilet for literally 12 years (not up in 12 years) and still vastly down from its values just 10 years ago, this is one of only 2 times (the other being the 70's) since WW2 when stocks have performed this badly for this long.
Now, lets say that you invest some money with a hedge fund that makes a 20% return each year (before fee's and taxes) and runs at a 2% annual fee + 20% of the profits. And lets say that it makes 20% each year like clockwork. Where does that leave you? Thats better, right?
Well, ... from reading the blogs of various hedgies and seeing how frequently they move in and out of things, and assuming that basically all of the profits are subject to income tax rather than capital gains tax,...
You would have made 20%. But you would pay 2.2% in fees (based on the average of.8 your assets over the course of the year), leaving 17.8%. Then you pay 20% of the profits, or 4%. Now you have 13.8%. And you are taxed every year via income tax (lets just assume that between federal and state this is 40%) on the 13.8%. So you pay 5.5% in taxes. This leaves you with 8.3%.
Worse than buy and hold.
Buy and hold = 9.7% in the last 60 years, higher when starting from a point where the market is well down.
A 20%/year hedge fund with (not all that high for the hedge fund industry) 2% fees and 20% of profits yields... 8.3%
Taxes are compounded frequently, fee's are compounded frequently, and it takes literally 3x the return (from a hedge fund setup) as it does from a buy and hold setup to JUST BREAK EVEN.
If hedge funds serve wealthy clients, as is typically said to be true, how honestly do they serve them? We assume this hedge fund makes 20%/year every year and never blows up. But haven't the preponderance of them eventually blown up? Didn't the preponderance of them blow completely up last year?
Based on this quick analysis and a year of evaluating various hedge funds and listening to their sales pitches and learning about markets and investing...
it looks like the rich folks that put their money with the hedgies are, truly, not better off than somebody dollar cost averaging into SPY.
They would have the benefit of no massive life-altering draw-downs like 2008/early 2009 (the hedge fund in this example is smooth and consistent). But, frankly, there is no reason to believe that hedge funds are consistent and not likely to implode about as often as the market itself implodes.
This short analysis doesn't look good for the hedgies, at least the ones with traditional 2%/20% fees.