Opinion

Index funds prove more safe, dependable than hedge funds

In the investment world, hedge funds are completely unnecessary. Many new investors in the stock market see hedge funds as a tantalizingly low-risk opportunity, but investing in them is ultimately a mistake.

Hedge funds are companies that manage assets for their shareholders. Rather than buying their own stocks, investors in a hedge fund are essentially paying trained analysts to buy stocks for them. The thinking is that the returns from a professional investment company would be greater than what the average person could earn, even after the hedge fund takes a fee.

In fact, the opposite is usually true. Hedge funds rarely outperform the market, charge exorbitant fees and have run afoul of the law regularly since the financial crisis.

Hedge funds are a bad idea for the simple fact that they are unprofitable. Hedge funds consistently underperform stocks, and have only done worse as of recent. In fact, after stocks experienced a massive resurgence in recent years, hedge funds have remained more or less stagnant. Moreover, they have been riddled with scandal. SAC Capital and PIMCO, two of the largest hedge funds, have been investigated by the Securities and Exchange Commission for insider trading and falsely boosting returns in one of their funds, respectively.

There is an alternative that works for people who want the security and hands-off quality that hedge funds seem to provide. The best choice of investment remains the index fund, a type of investment that bundles a group of stocks chosen automatically (generally from a major index, like the 500 biggest companies, hence the name “index fund”).

Because it serves as a sort of proxy for the stock market as a whole, an investment in an index fund is an investment in the stock market itself. And, in the long term, the stock market is one of the most consistently profitable economic sectors in the world. Though there are definitely shocks and downturns, over any reasonably large period of time, the stock market has about a 9 percent annual return.

Anyone with enough luck can outperform it occasionally, creating misconceptions about the wisdom of investing in hedge funds. But in the long run, there is nothing better than an index fund for a safe, dependable investment.

Andrew Langen is a sophomore majoring in economics and math.

November 19, 2014

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Andrew Langen


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