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My Financial Advice for 2008: Watch What Rich People Do and Do The Opposite!

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Since everyone is so comfortable giving their opinion on what is going to happen in 2008, let me toss my hat into the ring.

I can't offer you any predictions since I believe they are errant nonsense. However, here is some solid advice, based on reliable data that you can verify:

Watch what rich people do, and do the opposite.

Rich people invest in hedge funds. There are now more than 8,000 of these funds. They manage over $1 trillion in assets. Since access to these funds is open only to high net worth "qualified investors", they are off limits to the average person.

So, how sad should you be that you are shut out of these funds?

There is no doubt that some of them reported spectacular gains. How fortunate you would have been if you had invested in Red Kite Metals in 2006. It was up an astounding 188% And what about Second Curve Capital? It had two funds that were up 55%.

Clearly, the managers of these funds had that "special magic" that you would expect from elitist funds that charge exorbitant fees.

Now let's flash forward to 2007.

According to an article in The Wall Street Journal, Red Kite Metals dropped about 50% as of November 30, 2007. The Second Curve Capital funds were down almost 70% over the same period. Heavy investments in subprime lenders was apparently the problem. I guess they did not see that one coming.

Financial giant Bear Sterns lost $1.6 billion in two hedge funds and is now facing a lawsuit by Barclays, who invested $400 million in these funds.

Barclays is the world's largest investment bank. It claims it was snookered into investing in these funds.

Wow! The most sophisticated investment bank in the world turned out to be no match for one of the biggest players in the securities biz.

How do you like your chances?

Am I just cherry picking to make my point?

Not according to a study by Burton Malkiel (of Random Walk fame) and Atanu Saha. They published a study showing that on average every major category of hedge funds provided lower risk-adjusted returns than the S & P 500 from 1995-2003.

The high fees charged by hedge funds (typically 2% of assets plus 20% of profits) are the primary reason for their underperformance. In an article in The New Yorker, John Cassidy correctly observed:

Our research has shown that in at least 80% of cases the after-fee alpha for hedge funds is negative...I'm not saying they don't have skill; I'm just saying they don't have enough skill to make up for two and twenty.

David Swenson, in his excellent book, Unconventional Success: A Fundamental Approach to Personal Investment, noted:

Investors in hedge funds find generating risk-adjusted excess returns nearly an impossible task.

In what can only be explained as cognitive dissonance, pension plans, trusts, endowments, foreign governments and wealthy investors continue to pour assets into these funds.

For the rest of you, my advice is simple: avoid these funds. For that matter, avoid all funds and all "investment professionals" who tell you they can "beat the markets."

If you follow this advice, you might really have a prosperous 2008!

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