Have you dared to look at your 401(k) statement lately? If you have, you’re probably thinking unkind thoughts about the well-paid folks who are supposed to be managing your money.
I say it’s time to give ’em the boot—but let’s talk this through first.
Fidelity Magellan fund is a poster child for disappointing investment results. As October closed, the fund had lost 50.5 percent over the last year, according to Morningstar. That means the fund trailed the S&P 500 index by a whopping 12.2 percent over the last year. Similar disappointments prevail at other well-known funds such as Dodge & Cox Stock, American Funds Fundamental, and T. Rowe Price Growth Stock.
Mind you, this isn’t a universal event— not all funds have trailed a passive index. But most have.
It’s not supposed to be this way in a bear market. Managed funds should have a slight edge over index funds when the market goes south. Why? Because managed funds typically hold a portion of their assets in cash, while index funds tend to be fully invested at all times.
The difference in cash holdings means that managed funds won’t decline quite as fast in bear markets because not all of their assets are invested. Cash holdings have the opposite effect in a bull market. Because they are fully invested, index funds have an edge in bull markets, while managed funds, burdened with cash, don’t capture the full market rise.
Note that the bear market advantage of managed funds has nothing to do with portfolio manager smarts. It’s the inevitable result of operational necessities. In spite of this bear market advantage, index funds have, yet again, beaten most of their managed competitors. And they did this in most fund categories.
At the end of the third quarter, large-cap growth, large-cap blend, and large-cap value index funds had done better than 88 percent, 76 percent, and 56 percent of their managed peers, respectively.
Similarly, a small-cap growth, small-cap blend, and small-cap value index fund had beaten 75 percent, 53 percent, and 51 percent of managed peers, respectively. Only in the mid-cap domestic stock categories had the majority of managed funds beaten their competitive index.
Nor is there any relief when you go beyond the domestic stock market. Vanguard Developed Markets Index (ticker: VDMIX, expense ratio: 0.22 percent) beat a whopping 76 percent of all managed foreign large blend funds. And Vanguard Emerging Markets Index (ticker: VEIEX, expense ratio: 0.37 percent) beat 56 percent of all managed diversified emerging markets funds.
But if Fidelity Magellan failed against both an index and its managed peers, Vanguard Balanced Index (ticker: VBINX, expense ratio: 0.19 percent) represents the opposite pole. This humble fund, which invests 60 percent of its assets in the total domestic stock market and 40 percent in the total domestic bond market, has done better than 87 percent of its managed competition over the last 12 months. (This fund is no slouch over longer periods as well. Over the trailing 3, 5 and 10 year periods it has beaten 83, 77 and 67 percent of its competitors, respectively.)
While the losses we’ve all experienced are exceptional, this should not blind us to a possible balm: Collectively, we’re wasting billions of dollars every year on expensive managed mutual funds. Management fees, plain and simple, are seldom money well spent.
I was not aware of this when I started writing about investing 40 years ago. But every bit of research since then and regular examinations of practical data points to the same conclusion.
Portfolio managers, on average, are not able to beat a simple index.
They may be loved by their mothers, a delight to their friends, the life of every party, and a source of pride and contributions to their alma mater— but the raw, recurrent truth is that 70 percent of them fail to beat an index. Equally important, there is no proven way to select the ever-changing 30 percent who do beat their index from time to time.
The definition of insanity is doing the same thing over and over, but expecting different results.
So I’d like to offer an early New Year’s resolution. Demonstrate your sanity. Give your overpaid managers the boot.
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
(c) A. M. Universal, 2008