Long term, how do managed portfolios stack up against simple indexing?
To examine that question I went to the Morningstar database and found the domestic equity funds with the longest possible track records. The idea was to measure established funds against the Vanguard 500 Index fund, which has been in operation since 1976.
The number of managed equity funds in the sample is 74. The total fund “portfolio” numbered 75 when the index fund was included. From there, I checked the performance of the entire group, starting in different years. All periods ended March 31, 2002 and it was assumed that the investments were in tax-deferred accounts. Taxes were ignored.
Managed Equity Investing vs. the Largest Index Fund
| Start Year | Avg. Fund Return | Highest | Lowest | Vanguard 500 Index |
Index Rank |
| 1977 | 13.19 | 17.32 | 9.74 | 13.31 | 31 (of 75) |
| 1982 | 13.44 | 17.25 | 9.81 | 14.78 | 14 |
| 1987 | 11.86 | 16.73 | 7.27 | 13.33 | 10 |
| 1992 | 11.15 | 17.58 | 4.00 | 12.53 | 21 |
| 1997 | 8.85 | 16.55 | -3.54 | 10.16 | 29 |
Source: Morningstar, March 31, 2002 data
What do the results tell us?
Index investing works rather nicely. The index fund beat the average fund in all five periods.
Message: if you want to be in the top half of the class, index. It will never get you the top return. But history shows you’ll rank closer to the top than to the bottom. This means you’ll miss the experience of picking a Bottom Dog Fund.
In fact, these figures understate the performance of index investing. The fact that we started with a group of funds with long histories assured that our results have a “survivor bias”— the distortion of data caused by the regular removal of funds that have failed, merged, or otherwise disappeared.
These figures also ignore all taxes, assuming that your investment is in a tax-deferred account. Since investing in the S&P 500 Index is more tax efficient than the majority of funds, you can expect that relative performance would improve. From 1977 to the present, for instance, the Vanguard 500 Index fund had only a small advantage over the average without considering taxes, 13.31 percent vs. 13.19 percent.
If taxes had been paid year by year, the index advantage would have soared. The index fund accumulated at an 11.53 percent compound rate while the average managed fund accumulated at a 10.58 percent rate. The performance rank of the index fund would have climbed to 17 of 75.
Is this definitive proof of the superiority of indexing?
No.
It is only additional evidence that indexing is a smart choice for most people, most of the time. It is certainly a smarter choice than trying to choose the portfolio manager of the moment.
We have encountered this evidence in a multitude of ways over many years. Unfortunately, it never provides the absolute assurance most investors seek. What we learn is that index investing, most of the time, will provide results that are superior to most managed investments. The operative word is “most” and the word people want to hear is “best.”
The results will always leave the door open to claims of superiority from the management and sales community. Many of those claims will be true when they are made.
The question is how long will that superior performance last? It usually fades.
The second question we need to ask is more complicated—What is the consequence of seeking superior performance?
Answer: You have to live with the results.
Suppose, for instance, that you had invested $10,000 in the Vanguard Index 500 fund at the beginning of 1977. Your original investment, unimpeded by taxes, would have grown to $274,764. With 30 of the managed fund choices, you could have accumulated more. But with 44 of the choices you would have accumulated less.
Although this is the worst result for indexing in the periods considered, odds are we will accumulate more by indexing than by selecting “good” funds or “good” managers.
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or en
(c) Scott Burns, 2022