When most people think about investments, their minds immediately drift to vehicles such as mutual funds, hedge funds, bond funds, REIT’s, and other methods of pooled investments that are either managed or pegged against an index. Many noted academics such as Burton Malkiel have rightly observed that most active managers fail to beat the market portfolio, and that it is optimal to simply purchase the market portfolio at the lowest cost possible.
However, there is another aspect to consider in regard to pooled investment and investment funds. This factor is that large pools of capital can only pursue large investments. Upon deeper analysis, this reveals that anything which cannot be scaled into a large-scale portfolio will necessarily be overlooked by any aggregated funds or indexes.
In many cases, there are small, fragmented opportunities where investors can capture very high rates of return, but are not scalable into pooled investment funds. Examples of this phenomenon are single-family income properties, and small privately held companies. These investments are too small to be captured in indexed portfolios, so the high rates of return that they can produce accrue only to those who invest in them directly.
Thus, it becomes true that “Big Kid” rates of return only go to direct investors. Anybody who trusts a fund manager to select investments on their behalf places themselves at the mercy of that managers decisions. In addition to this, consider that most fund managers are compensated by receiving a percentage of the fund asset base. Because of this, their incentive is to attract new investors, which grows the capital base, and makes it impossible for them pursue anything outside of large-scale opportunities that typically produce only average rates of return.
When constructing your personal investment portfolio, there is probably a place for pooled investments such as the market portfolio. For the portion of your investments where you are satisfied with the ‘average’ market rate of return and don’t want to babysit the capital, the market portfolio can be optimal. However, if you are seeking to achieve rates of return that the “Big Kids” like Jason Hartman, Donald Trump, and Robert Kiyosaki talk about, it isn’t going to happen in a mutual fund or REIT. Only direct investors can achieve these levels of returns.
The rub is that being a direct investor requires much more research, courage, and discipline than purchasing a pooled investment. By taking the effort to become educated, developing the discipline to follow fundamentals, and fostering the courage to act, these returns can be yours. It all comes down to what efforts you are willing to make for the sake of your financial future.
Action item: Develop the knowledge, discipline, and courage to become a successful direct investor so that you are able to capture the rates of return that are out of reach for “average” investors. (Top image: tungphoto)
The Jason Hartman Team
