Kicking the fund-trading habit

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(Money Magazine) -- Question: I've spent five hours a week researching and tracking mutual funds for the past 20 years and currently have about 18 actively managed funds.

It seems like I should just create a proper mix of index funds and let it go, periodically rebalancing between funds.

I'm thinking this would be much smarter, save time, reduce stress, and in the end, the performance would be comparable.

Am I missing something? Is it really this easy?

The Mole's Answer: Investing can really be that simple - and you don't need to sacrifice performance by taking the easy way out.

Think about it. By my math you've clocked more than 5,000 hours during the past 20 years to pick mutual funds. While I haven't seen your results, I have a strong inkling that your reward for all of this effort was underperforming the stock indexes.

You'd certainly think that working hard and smart to pick the best mutual funds should result in better performance. But it rarely works out that way.

That's because nearly all the research you can do is backward looking.

With thousands of mutual funds, the ones that have performed well over a short period, like five years, will show up at the top of your charts. But their good performance can usually be chalked up to luck. By the time you send the hot fund your money, you're set up for a few years of bad times.

A lot of people who research and track these funds, also buy and sell frequently. That triggers tax implications and opens you up to a whole lot of human error.

Plus, actively managed funds charge far more in annual expenses. Those can really eat into the returns you get.

So it really is much more effective to invest in the entire U.S. and international stock market using a handful of index funds. You can then forget about your portfolio, other than maybe rebalancing once a year.

You save in expenses and taxes - not to mention what you save in stress.

I suggest building a core equity portfolio of stock index funds. Use a total U.S. index fund, from either Vanguard (VTSMX (Charts) or Fidelity (FSTMX (Charts).

Do something similar for international exposure, with something like Vanguard FTSE All-World Ex-US Index (VFWIX (Charts).

Exchange traded funds from I-Shares can also give you this broad diversification with even lower costs. Usually mutual funds make more sense than ETFs if you plan to contribute regularly throughout the year, because you don't have to pay commissions with each transaction.

Mixing in a small portion of a REIT index fund may add some diversification. Bond index funds are also a good alternative, though some high-yielding CDs can also work well.

If, after 20 years of active investing you can't get over the thrill of trying to pick a winner, then go ahead and gamble - but keep it to a small portion of your portfolio, say five to ten percent.

If you're ready to step away from the researching in favor of index investing, you'll find the trade-off will give you returns much greater than most individuals and professionals will get. Unfortunately, they are just not much fun.