I am an idiot.

[elfs]

So, being forty, I'm reading through investment and retirement planning packages. I'm learning an awful lot about hedge funds, REIT (real estate investment trusts), exchange traded funds, and so on. Lots of interesting and surprisingly geeky data throughout. Oh, I know I'm bad at this, but I want to at least have a grasp on what my family's new financial adviser has to say when he says it.

My new FA is big on hedge funds. (In fact, the day I met him was the day the Bear Stearns hedge fund, heavily leveraged in sub-prime mortgages, was seriously hitting the fan, and he said he admired my willingness to ask him about that.) He talked about having a diversified collection of hedge funds as one asset allocation class, and I was sitting there trying to figure out what the heck that meant.

I figured it out today. You can have hedge funds in different investment classes: commodities, energy, technology, transportation, etc. The average annual performance over the past decade for all hedge funds is 10.48% return with 7.22% deviation, meaning for any given fund (again, this is all averages, just as an example), there's a 68% chance that your return will be somewhere between 17.7% and 3.26% (10.48%±7.22%) and a 95% chance that the return will be 24.91% to -3.96% (10.48%±(7.22%×2)). That's right, there's a slight risk you could lose some of your investment in a given fund

The idea is to selectively choose a lot of different hedge fund investments, so that the average performance across the portfolio approaches or even exceeds the average of all of them. I mean, this may seem blazingly obvious, but it never quite clicked for me. I suppose the same is true for any investment tool, but I had to be reading about something as esoteric as a hedge fund to figure it out.

Y'know, ever since someone showed me the way standard deviations are used to describe risk in investment tools, I've been much more comfortable with understanding the risks that I might someday take.

If I ever have any money.

Comments

[jenk]

Interesting. What kind of fees do they have?

For contrast, Vanguard's basic S&P 500 index fund has a 12.24% annual return since its inception in 1974 and a 7.05% annual return over the last 10 years. It also only charges a fee of 0.18%.

A broader index, Vanguard's Balanced Index Fund (40% bonds / 60% stocks), has a 9.34% annual return since its 1992 inception and 7.24% in the last 10 years. Its expense ratio is 0.2%.

Of course, an index can't beat the market it's indexing. But you also won't do much worse than the market, either.

[dr-memory.livejournal.com]

Interesting. What kind of fees do they have?

...and what kind of commission rate is Elf's FA getting for recommending hedge funds to an individual investor?

Seriously, I am neither an economist, accountant nor certified financial planner/advisor, so take this for what little it's worth, but if I infer correctly from your post that this is your first foray into retirement planning and this person is steering you immediately toward hedge funds rather than a solid base in Vanguard and Fidelity's index funds... I would recommend seeking a second opinion, and quickly. (If I infer incorrectly, and in fact you're looking to play around with some money that you're comfortable having a high risk of losing... good luck and vaya con dios.)

Well...yeah

[jenk]

I am also not a certified financial anything, so I tend to point out "Hey, look what you can get here" instead of saying "Whaaaat???" But, yeah.

(My current 401(k) is at Fidelity because that's how the company set it up. It's in an index fund, and with the 401(k) discount the fees aren't bad. Previous 401(k) has been rolled over to Vanguard's balanced index fund. Roth IRA is at Vanguard. Other cash I've squirreled away is at Vanguard. I do occasionally dabble in individual stocks, but not much.)

Oddly enough, I recently posted some examples of how 401(k) saves you money at http://jenk.livejournal.com/tag/money.

[antonia-tiger.livejournal.com]

I Googled on "hedge fund".

I'm afraid that what I found set alarm bells ringing. OK, I'm not a risk-taker, but this doesn't look like a good idea.

[shunra.livejournal.com]

It's not just about risk-taking. It's also about pyramid scams (of sorts): when the growth of an industry requires lots of new investors in it, it will eventually reach the peak of investment, and become worth less (or possibly, worthless).

Hedge funds were born as a special kind of mutual fund, which did not have all the pesky and expensive-to-implement legal protections of the "normal" funds. They've successfully lured a large part of the wealth of a large number of wealthy people into themselves, and are now trolling for the less-wealthy, because the fantastic growth in value needs to come from somewhere.

I'm not a financial expert in any sense of the word, though. Maybe I don't understand what the hedge funds are.

[antonia-tiger.livejournal.com]

I'm not sure that I do either, but "hedging" is a way of reducing risk by buyiong and selling on a futures market. It was still the Baltic Exchange when I was involved, they have a trendier name now--but the idea hasn't changed. You sell a 100 ton wheat future for GBP 110 per tonne, and when you sell 200 tonnes of physical wheat you finish with the average of the future and the spot market price. Though the futures dealing never seems to involve anyone getting their hands dirty with a shovel, loading lorries.

You can do the same buying goods. A flour mill might have bought a future contract, to limit the cost of grain to them. If the spot price is higher when the future matures, I lose and they win.

Most of the trade is speculation, and the brokers make their money from the marguin between buy and sell prices--they have their own jargon that I don't remember.

I'm not sure how any of that links to a "hedge fund", but I saw the stuff about less regulation. Not a good sign.

[shunra.livejournal.com]

I think it's the less-regulation that makes it hardest for me to accept. The whole point of the regulation was that in previously unregulated markets, someone ended up getting greedy and basically crossed the line between speculation (which is fine) and con jobs (a la Enron).

The problem with "unregulated" is that everyone thinks they'll be at the high (=moneymaking) tiers of the pyramids. And some people really will. Much in the same way that some people really do win the lottery. But most players will - by the nature of the game - lose.

One of the things that bothers me about hedge funds is their very name. Hedging is indeed what you describe. However, hedge funds do not necessarily do that.

From the Wikipedia article about them:

Though the funds do not necessarily hedge their investments against adverse market moves, the term is used to distinguish them from regulated retail investment funds such as mutual funds and pension funds, and from insurance companies.

[antonia-tiger.livejournal.com]

Remember to figure in inflation and opportunity cost. If you don't cover inflation, or if you don't match what a bank deposit account will pay, you're still losing money.

I've only come across hedging with the futures markets, where it can be used to limit your losses, and your gains. And I've seen a lot of scary stories about derivatives in general. I'm almost glad I don't have enopugh money to take that sort of chance.

[gromm.livejournal.com]

Heh. The best investing tool you can have though, is to start investing when you're 20. Like my wife did.

I didn't start until I was about 30, but I knew there was a reason I married her. ;)

[en-ki.livejournal.com]

My understanding is that reported performance of hedge funds is heavily affected by survivorship bias.

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My understanding is that reported performance of hedge funds is heavily affected by survivorship bias. <a href"http://philip.greenspun.com/materialism/early-retirement/investing">Greenspun distilled some books about this sort of thing into a web page.</a>

[woggie.livejournal.com]

Ah, the gift that keeps on giving. Now I get to try to figure out what the hell that means. Sigh.