Let's talk about the dirty little secret on Wall Street.
You might have heard about hedge funds. These are the elite clubs of Wall Street. Investors, often highly wealthy, combine their money, and a hedge fund manager tries to beat the market with it.
These are "the suits," the billionaire managers who aggressively trade or short stocks, using any edge they can find. Examples of these wealthy fund managers include names like Bill Ackman and David Tepper.
But did you know that you can beat the pros?
The craziest part is that you can outperform the average hedge fund, working less than they do.
Here is how.
Beating the market is hard
Every hedge fund's goal is to generate market-beating returns for its clients. Fund managers are often paid based on how their fund performs. However, the nature of the business forces most hedge funds to focus on the short term, which is much more challenging because the stock market can be pretty darn irrational.
That doesn't stop people from trying. According to Mordor Intelligence, over 3,400 active hedge funds exist in the U.S. Occasionally, a fund manager can become famous for a colossal trade or a stretch where their investment strategy excels. But generally speaking, it's hard, even for the best-paid professionals, to outrun the S&P 500 (^GSPC 0.54%) over time.
Data from an article by The American Enterprise Institute charted the average hedge fund's performance from 2011 to 2020. Over that stretch, the typical hedge fund underperformed the S&P 500 every single year. Again, there will be an occasional manager who outperforms, but rarely does it last long.
Famous investor Warren Buffett even won a bet once. He wagered that an index fund tracking the S&P 500 would outperform a basket of hedge funds over a decade. The S&P 500 (and Buffett) won that bet decisively.
Why is the S&P 500 so good?
Understanding how the S&P 500 works will help illustrate its effectiveness. It's an index by Standard & Poor's that holds 500 of America's best corporations. A committee oversees the index and determines whether companies are taken in or out. The collective market cap of the member stocks determines its weightings.
The point here is that the index evolves. Performing stocks steadily contribute more to the index, and the committee ensures it holds only the best companies.
^SPX data by YCharts
Ultimately, the S&P 500 reflects the best the U.S. economy offers. Even the index can have a bad year, but historically, the S&P 500 has continually risen over time through recessions, wars, and catastrophes. Its annual average return is about 10% historically.
How you can invest in the S&P 500
For such a remarkable wealth-building machine, using it for yourself is straightforward. There are a handful of index funds that mimic the S&P 500. Some popular examples include the SPDR S&P 500 ETF Trust and Vanguard S&P 500 ETF. These funds also cost very little to buy and hold. Their expense ratios are both just 0.09% and 0.03%, respectively.
You can set up an investment account and automate regular purchases of these funds, slowly but surely building a position. Given the U.S. stock market's historical resiliency, you can feel pretty good that you will have much more money in the future because of the S&P 500.
It doesn't take a billionaire hedge fund manager to make you wealthy.
Justin Pope has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends S&P Global and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
FAQs
We focus the most on the business fundamentals of the companies in which we invest, rather than on their stocks' short-term price changes. When we recommend a stock to any user of our premium subscription services, we are recommending that you buy and hold the stock for a minimum of 5 years.
Which hedge fund strategy has the highest return? ›
Across main investment strategies, event-driven followed by distressed debt hedge funds lead the pack in terms of 2021 performance, with their 13.56% and 13.14% returns respectively.
What is the average rate of return for hedge funds? ›
All hedge funds tracked by BNP Paribas returned an average of 7.66% in 2023, differing from the survey results released on Feb. 12. In 2022, these hedge funds returned an average of 0.42%, said a BNP spokesperson. However, survey respondents said their hedge fund portfolios returned an average of 1.1% in 2022.
Why do most hedge funds fail? ›
Some strategies, such as managed futures and short-only funds, typically have higher probabilities of failure given the risky nature of their business operations. High leverage is another factor that can lead to hedge fund failure when the market moves in an unfavorable direction.
What is the 4% rule Motley Fool? ›
It states that you can comfortably withdraw 4% of your savings in your first year of retirement and adjust that amount for inflation for every subsequent year without risking running out of money for at least 30 years.
What is the rule of 72 Motley Fool? ›
Applying the Rule of 72, you simply divide 72 by 10. This says the investment will need to go up 7.2% annually to double in 10 years. You could also start with your expected rate of return in mind. Perhaps you expect a stock to go up in value by 15% annually.
What is the 2 20 rule for hedge funds? ›
The 2 and 20 is a hedge fund compensation structure consisting of a management fee and a performance fee. 2% represents a management fee which is applied to the total assets under management. A 20% performance fee is charged on the profits that the hedge fund generates, beyond a specified minimum threshold.
What is the most successful hedge fund in history? ›
Citadel has generated roughly $74 billion in total gains since its inception in 1990, making it the most successful hedge fund of all time.
What is the most profitable hedge fund in the world? ›
Citadel has now made $74 billion for investors since its inception in 1990, more than any other hedge fund firm.
What is the average lifespan of a hedge fund? ›
As a quantitative researcher who previously worked in the hedge fund industry, Farnsworth has been studying hedge funds for quite some time. Over the years, he noticed that the average lifespan of a hedge fund is quite short – less than five years.
Goldman, which has helped launch and finance thousands of hedge funds, said almost all newcomers survive their first year but that only 62% of all funds remain in business after five years.
How much money do you need to be considered a hedge fund? ›
It is not uncommon for a hedge fund to require at least $100,000 or even as much as $1 million to participate. Unlike mutual funds, hedge funds avoid many of the regulations and requirements within the Securities Act of 1933.
Are hedge funds dying out? ›
“Hedge funds have been in decline for over a decade. In a low interest rate environment, the fixed fees became less attractive,” Sonnenfeldt told CNBC via email, adding that hedge funds could no longer “deliver exciting returns.”
Why are hedge fund returns so poor? ›
The authors say, “This happens because about sixty percent of the gains on which incentive fees are earned are eventually offset by losses.” 1 They calculate a 3.44% average annual cost of AUM for the hedge fund industry between 1995 and 2016.
Why are hedge fund owners so rich? ›
Hedge funds seem to rake in billions of dollars a year for their professional investment acumen and portfolio management across a range of strategies. Hedge funds make money as part of a fee structure paid by fund investors based on assets under management (AUM).
Does Motley Fool really beat the market? ›
Motley Fool Stock Advisor has a strong track record of stock recommendations with investment returns that have outperformed the broader market over the long term. Investors are still advised to diversify their portfolios with more than just Motley Fool Stock Advisor's picks.
What stocks does The Motley Fool recommend? ›
The top 10 stocks to buy in September 2024
- CrowdStrike (CRWD 1.23%), $58 billion.
- PayPal (PYPL 0.01%), $66 billion.
- Airbnb (ABNB 1.16%), $72 billion.
- Shopify (SHOP 1.69%), $89 billion.
- MercadoLibre (MELI -0.53%), $96 billion.
- Walt Disney (DIS 1.49%), $156 billion.
- Intuitive Surgical (ISRG 0.09%), $165 billion.
The Motley Fool steers investors away from the allure of short-term gains. Their philosophy advocates for a long-term perspective, recommending holding stocks for at least 5 years, ideally for a 10- to 25-year timeframe.
How much money do you need to invest with Motley Fool? ›
We are proud to offer stock ownership and professional management all the way down to $6,000 - that's less than one year's IRA contribution! Account minimums generally start at $6,000, but can be much higher (e.g., $300,000) based on account allocation, holdings and strategies (e.g., use of options and shorts).
