Mark Hulbert discussed an interesting new study in Sunday's New York Times. He sums it up: "Don't even consider holding actively managed mutual funds unless you're willing to switch funds often. All other fund investors should simply buy and hold an index fund for the long term."

The author of the study argues that mutual funds underperform over the long-term not because of the inability of professional managers to pick stocks, but because of the way money flows into funds affects returns. That's right! Blame yourself for the poor performance of your funds! Basically, Jonathan Berk, the University of California professor who wrote the paper, argues that managers who perform well attract greater investments and so the funds stop performing well.

The professor suggests a complicated method of checking your funds regularly and selling bottom-performing funds and buying top-performing ones -- sounds to me a lot like performance-chasing. It also seems to run contrary to Berk's complaint that managers who perform well take on too much in the way of assets. Isn't performance-chasing what causes that problem?

Particularly given the costs of switching funds frequently (mainly taxes), I think investors will still do far better owning index funds. It's a lot easier too, isn't it?

In his column "The Intelligent Investor" in the latest issue of Money Magazine, Jason Zweig offers some great tips for investors to "Stop worrying and stay invested" in the presence of a volatile markets. He also gives one of the best pieces of advice for trading that I have ever seen: "Wait for the bell. If the market is open, your portfolio should be closed. Later you can be more objective."

Don't worry about missing opportunities: All the research shows that frequent trading kills performance. Trading during the day will trick you into making impulsive investments, and make your regimen more gambler than cerebral. This also goes nicely with one of the best investing quotes of the year, from John Bogle's interview with the same magazine in March: "The stock market turns out to be a giant distraction from the reality of owning businesses, which is what investing really is. In the short run, expectations seem to drive the market, but in the long run nearly 100% of the returns on stocks come from the real market - the sum of dividend yield and earnings growth."

Zweig's advice is certainly something I plan to incorporate into my own investing. For more great insight from Zweig, buy the most recent edition of Benjamin Graham's classic book The Intelligent Investor, which has timely commentary from Zweig following each chapter.

In the classic comedy Rush Hour 2, Chris Tucker explains his method of detection to Jackie Chan:

James Carter (Chris Tucker): Lee, let me introduce you to Carter's new theory of criminal investigation: follow the rich white man.
Lee (Jackie Chan): Follow the rich white man?
James Carter: Behind every big crime there's a rich white man waiting for his cut.

And sure enough, according to MarketWatch, most hedge funds made out like bandits in February, as they had correctly forecast the subprime lending crisis that led to the collapse of companies like Novastar Financial.

In the mind-boggling world of credit derivatives (Incidentally, go pick up a copy of Traders, Guns, and Money), even the experts can't quite seem to figure out who was bearing the risk that allowed the funds to succeed. Some suggest pensions funds and overseas investors, but no one really knows.

Tuesday's Wall Street Journal featured one of the most interesting pieces [subscription required] I've seen in a long-time. It's kind of like the old VH1 show Where Are They Now? where you found out that the singers you loved in high school are either on coke, living on a farm or recording gospel music.. Except the Wall Street Journal piece is about mutual fund managers.

Do you remember those internet funds during the late 1990s that were achieving triple-digit annual returns, enticing retail investors to pour billions into them right before the internet bubble burst? But while they lasted, their returns were impressive:

At the end of March 2000, there were 275 funds -- about 9% of the stock funds around at the time -- posting gains of 100% or more for the previous 12 months, according to fund tracker Morningstar Inc. Of those, 24 funds returned more than 200%, and one, PBHG New Opportunities, shot out the lights with an astonishing 533% gain.

Morningstar tracked down the funds and fund mangers achieving those mind-boggling returns. Check it out:

While Robert Kiyosaki (of Rich Dad, Poor Dad fame) has railed against mutual funds for years (while simultaneously suggesting multilevel marketing schemes), it appears that he may have been right: rich people really don't seem to like mutual funds. According to a study discussed in the Wall Street Journal (registration required) few wealthy investors are satisfied with the performance of their mutual funds. With good reason: over the long-term, passively managed index funds outperform most mutual funds.

One of the few fund companies that earned high marks from high net-worth investors is Vanguard Group, which was among the first companies to offer mutual funds. Vanguard still offers some of the lowest cost index funds around and, if you only choose one fund company for your retirement planning, Vanguard may be the way to go. Congratulations Vanguard, and keep up the good work.

On a side note, Vanguard founder John Bogle has written some amazing books about business and investing: Common Sense on Mutual Funds and The Battle for the Soul of Capitalism belong on the bookshelf of every serious investor. If Common Sense seems too intimidating, pick up his new Little Book of Common-Sense Investing instead. While it really is a little book, it has everything you need to know to beat the vast majority of professional money managers.

Vanguard founder and tireless investor advocate John Bogle is one of my heroes (along with Warren Buffett, Abraham Lincoln, and Joe Montana). The latest issue of Money features an interview with the 77 year-old legend, who offers one of the greatest quotes about investing I've seen in a long, long time: The stock market turns out to be a giant distraction from the reality of owning businesses, which is what investing really is.

Next time you're glued to your TV watching the market drop a couple percentage points in one day, or you fret about your latest stock pick which is down 10% since you bought it, remember Bogle's words. They will save you a lot of worrying, and rescue you from the enormous costs that come with trading too frequently. Here are a couple John Bogle books you absolutely must read:

The Battle for the Soul of Capitalism: While not a book about investing per se, Bogle's treatise on what's wrong with corporate governance in America, and the financial services in general is powerful stuff.

There are some truths that you really don't need a study to know. Dropping out of high school is a bad idea, eating at McDonald's every day frequently leads to obesity, and now this one: the 2+20 formula for calculating management fees for hedge funds has a serious impact on their performance.

For those of you who aren't familiar with these funds, 2+20 refers to one of the most common fee structures for hedge funds. The manager collects 2% of the assets under management of a fund each year and then 20% of the fund's profits, often over a certain benchmark.

This compares to investing in an index mutual fund, which can be done for an expense ratio of as little as 0.2% of assets under management, with no performance fee. So without even factoring in the hedge fund's performance fee, it is already 10 times as expensive as an index fund. The question that hedge fund investors need to answer then, is this: can the fund provide strong enough performance to compensate for the enormous fee structure? The answer is that, on average, they can't. The average hedge fund doesn't perform better than a passively managed index fund each year.

According to a piece by fund guru Mark Hulbert in Sunday's New York Times, Mark Kritzman, a money manager who teaches at MIT's business school, found that investors would be better off allocating their investment money to index funds than hedge funds. This results in part from the asymmetry of the compensation structure, in which the fund collects a performance fee for good performance but, of course, pays no fee to the investor in the event of poor performance.

Mr. Kritzman summarized his work by saying that ""Because of fees, the optimal allocation to a group of hedge funds is a lot lower than you might think it should be."

So let the small investor sleep well. Just because you don't meet the requirements to be a "qualified investor" for a hedge fund doesn't mean you have to sacrifice performance. In fact, not being subject to the allure of these ever-so-sexy alternative investments may actually improve your returns.

A big rule in books I've read from John Bogle to Peter Lynch to Warren Buffet always comes down to one single phrase that has never left my mind (and has done me well): invest in what you know. It's hard to invest in what you know if you are using auto-pilot solutions like index and mutual funds unless you scrutinize the industries those funds participate in as well as costs and other investing tidbits that all investors should really take the time to know. After all, it's your money -- where is it going? Invest yourself in information and then let your money do what it needs to, right?

This article over at Forbes tells of Dean White and his journey of 80+ years, as he's gone from teenage hard worker to billionaire real-estate magnate who built his fortune in the billboard industry. With that division gone, his sole focus now is the apartment industry, something Dean knows very, very well.

Which comes back to why billionaires get to where they are. In most cases, it takes decades (except the tech boom recently) to find out which industries you know, how to make money in them and how to stay personally invested in the areas where your money is working hard for you. After all, throwing wads of cash into a gaping hole -- and not knowing where it leads -- is the mistake many investors make. There could be a money-copying machine at the other end of that hole or even a paper monster ready to eat all those bills. Which would you rather have?

Each year, Money, along with the rest of the financial press, trots out its favorite mutual funds for the new year. I have a suggestion for how savvy investors can use such guides to select mutual funds: crumple them up, throw them in the trash. Then read The Boglehead's Guide to Investing, a great treatise on investing the John Bogle way. After that, log on to Vanguard.com and buy some indexed mutual funds.

But I digress. Here's why you should ignore Money's list of "the best mutual funds you can own." According to their own statistics, 67% of the "Money 70" funds performed in the top half of their category in 2006. That's a fairly impressive short-term track record, but certainly not amazing. It's even less amazing when you consider that Money screened for funds with low expense ratios, and the average fund that they selected had an expense ratio just over half that of the average mutual fund.

Here's the problem: according to all the relevant research (most notably in John Bogle's book), there is an extremely high correlation between a fund's expense ratio and its performance. It's the single most important factor in selecting a mutual fund. While I haven't run the data, I suspect that simply selecting all mutual funds with low expense ratios would provide a success rate better than the 67% that Money reported for their list. I just don't see anything particularly special about Money's list, and certainly nothing worth spending a few dollars on a magazine for.

Bottom line: the most important factor in selecting mutual funds is the expense ratio. To achieve strong diversification at an extremely low cost, consider buying Vanguard's total market index funds, as well as some of their international index funds for additional diversification.

Fundamental indexing is a method of semi-passive investing that consists of buying and holding stocks based on some quantitative metric, such as buying the stocks with the lowest price/earnings ratios in the S&P 50, or buying small-cap stocks with low price/book ratios. It can involve reweighting indexes or creating new ones. Index investing pioneer John Bogle is blunt about how he feels about it: "It just doesn't make sense," he told the New York Times.

The idea of fundamental indexing as a means of beating the market doesn't make sense to me either. While it's quite true that, historically, low price/book and low price/earnings stocks have outperformed over the long run, the fact that investors are now clamoring to capitalize on this nearly guarantees that it won't work in the future. If everyone decides to buy low P/E stocks, this will drive the price up, and they won't be a great deal anymore.

When looking at any investment product, investors need to remember the greatest understatement the world has ever seen: "Past performance may not be indicative of future results." The question is not whether certain fundamental indexing strategies have worked in the past. It's whether they will continue to work in the future.

Jonathan Clements has a piece [subscription] in yesterday's Wall Street Journal about how some financial advisers manipulate their current and prospective clients. He talks about tactics such as asking for a large investment first, so that a smaller investment will seem reasonable when it might not have originally. (In psychology, this is known at the door-in-face technique.) He also talks about how advisers will feign friendship or attempt to rush clients into investing with a "scarcity pitch."

One thing he doesn't discuss: Why use a financial adviser at all, since they are all basically salespeople? After the large fees that they extract and the strong unlikelihood of their providing superior returns, most investors would be better off picking index funds for themselves. Bottom line: Rather than trying to find ways to deal with their sales pitches (such as giving yourself time and avoiding snap decisions), why not just avoid them all together?

Investment advisers are business-people who seek to maximize their own profits. (For an excellent piece by John Bogle about how many mutual funds work, click here.) The single largest factor in determining your returns is the expense ratio, and advisers simply tack on another set of fees, which reduces your return. Enterprising investors willing to do minimal research can probably do better without them.