Concentrated portfolio of stocks or Index funds or Mutual/Hedge funds

How should I invest in the stock market?

Should I invest in my own selected stocks and manage my own portfolio?

Should I entrust my money to the fund managers in mutual funds or hedge funds?

Or, should I just buy an index-linked fund or an ETF?

Investing in mutual funds and hedge funds

The problem here is, as an aggregate, these funds underperform the market, after taking into consideration the costs incurred.  

Over a one year period, these costs maybe small, but over a long period, these costs compounded into a huge amount that is leaked out of your portfolio, not available to you to reinvest into your portfolio.

It is generally sound to avoid these funds, since there are better alternatives.

Investing in index linked funds or ETF

Index linked mutual funds have on the aggregate given you the chance to capture the returns of the market at low costs.    

They have in general outperformed the mutual funds and hedge funds, as a group over the long term.

Due to recent awareness of the performances of the mutual funds and hedge funds due to the higher costs involved, more and more money are flooding into index linked funds or ETFs.

Investing in a concentrated portfolio of  a selected group of stocks

I believe this is possible for those with a good and sound philosophy and method; who are hardworking, knowledgeable and disciplined.

These constitute less than 5% of the investors in the market.

An example of a sound philosophy:

• Know the business you are investing.
• The business has durable competitive advantage.
• The management has integrity and are capable.
• The company is available at a fair or bargain price.
• The investing time horizon is long term (> 5 years or more).
• Dividends are reinvested.

The stock markets have returned averagely about 10.5% per year for a long period.  The returns of the stock market over the short term is extremely volatile; inflation over this short period is small.   On the other hand, the returns of the stock market for any 5 years or more rolling period have always been positive.   Those who choose the "good quality stocks" bought at "bargain prices" can expect to perform better than the average and should have returns better than the 10.5% per year.

In summary:

1.   If you are knowledgeable, do invest on your own.

Own a concentrated portfolio of good quality stocks (those with durable competitive advantage).

Do not overpay to own them.

Keep them for the long term, reinvest the dividends, and allowing compounding to give you the higher returns.

2.   If you are not so knowledgeable, but still intelligent in your investing.

Go for index linked funds.

Do you have the uncanny ability to pick out the best mutual or hedge fund managers?  If you have, you may wish to park your money with them.  If not, avoid these products altogether and go for index linked funds or ETF.