Don't Invest in Hedge Funds

Stick with boring, old index funds


There are some ideas worse than putting your money in a hedge fund -- like burning it -- but not many. Indeed, the supposedly smart money has not been so for the past decade, at least not for actual investors. But now, with hedge funds free to advertise for the first time, don't be surprised if you hear about the outsized returns they offer.

Ignore them.

20121222_FNC667.pngNow, hedge funds aren't exactly coming to the masses. The Securities and Exchange Commission did decide that hedge funds, private equity funds, and start-ups can start marketing themselves, but they can only market themselves to "accredited investors" -- that is, rich people. You still need $1 million in assets, excluding your primary residence, or to have earned at least $200,000 each of the past two years to qualify for this tony-investing club. So, as Dan Primack of Fortune points out, it's not as if hedgies will start taking over the airwaves -- but they might take over the pages of The Wall Street Journal. At the very least, they'll be sure to talk up their past results, which they were forbidden from doing before.

Not that there's much to talk up. As you can see in the chart to the right from The Economist, hedge funds have cumulatively underperformed a simple 60-40 stock-bond index going back to 2003 -- and underperformed it badly. Hedge funds have returned just 17 percent after fees the last decade; a stock-equity index returned over 90 percent. (Even adjusted for risk, hedge funds likely come out well behind). Now, it's certainly true that there are a few hedge funds that can and do consistently beat the market -- which are, in other words, worth the fees. But those hedge funds don't want your money. They have more than enough investors already. That leaves people looking for the Next Big Fund -- and that's not easy. Can you tell the difference between someone who just got lucky, and someone who is actually good?

In other words, the hedge funds that do advertise will the ones you shouldn't invest in. Funds like well-coifed, Wall Street 2 extra Anthony Scaramucci's fund-of-funds -- which is just him investing in hedge funds for you, with, of course, a second layer of fees larded on. Or funds that warn old people who think it's still the 1970s that the Fed is DEBASING THE DOLLAR, and only they hold the secret to protecting your wealth from Weimar 2.0 -- what Noah Smith calls affinity fraud.

But for 92 percent of us, it doesn't matter whether hedge funds can or can't advertise. We can't invest with them regardless. And that's not a problem. See, the rich are different from you and me -- they blow their money on hedge funds, instead of lottery tickets.