Very few mutual funds beat their index in any year. Over five years, almost none have done so. These mutual funds have expensive managers (and expensive research). Unfortunately for the shareholders, the managers do not add as much value as their expense. The question is: why not buy the index itself? Index funds have almost no management fees, have no front or back loads, and beat virtually all managed mutual funds.
Technical trading is a method to extract as much commission from you as possible. Often, brokers will use terms like the “stock is above its 30 day average”, “head and shoulders”, etc. Technical trading claims to be able to predict stock market direction based on past relationships from graphs and lines on the chart. The claim is false, as the movements of individual stocks are random. How a stock moved in the past has no effect on how it moves in the future.
In general, the commission for stock trading can be many times greater than what you may think. One part of the commission is the advertised price: $9.99 per trade. A much larger part is the spread. For instance, if you order a stock sold at $40.00, brokerage firms do not actually sell until it is a little past that point (say $40.125 or more). They only give you $40, less commission, and keep the difference. If you order a stock at $40.00, brokerage firms do not buy until it is a little below that point (say $39.875 or less). They charge you $40.00 plus commission but only spent $39.875.
The first rule of finance is that there is no free lunch. Risk and return are related. You cannot have more return without taking more risk. Risk-free investments yield little or no return (like money market accounts). Very risky investments on average have the potential to yield high returns but are very volatile. You may even lose the entire investment. Thus, risky investments should be held within mutual funds.
There are two kinds of risk.
The first kind of risk can be managed through diversification. If I own an index fund that has 500 big companies (like the S&P 500), one company’s disaster (the BP oil rig explosion, for example) will not affect the index much. If I own BP stock directly, I will get hurt.
The second kind of risk is system-wide. If economic or political events cause the entire market to fluctuate, it affects all stocks.
Diversification does not counteract system-wide risk but can help manage non-system risk.