Sunday, April 28, 2013

Motley Fool: Mutual Fund Pros Falter

This was publish in the Bee's business page today.  I've advocated investing in indexed funds for a long time.

I put $10,000 into the Vanguard S&P 500 index fund in July, 1996.  Today, that account is worth $32,465.63, after re-investing all the dividends.

When the tax law changed in 2000 allowing me to convert my IRA into a Roth, I did that.  And that account has grown by 58.01% in the 3 years, all invested in index funds, with about half of it in the Total Market Index Fund and the other half in the S&P 500 Index Fund.

My philosophy is to invest money I won't need for at least 10 years into index funds and just let it sit.  No one can time the market with consistent success.

If you change your investment strategy, however, beware of any potential tax consequence.

Fool’s School
Beware of the Experts

Some have accused professional mutual fund managers of being no better at picking stocks than a dart-throwing chimp. That’s insulting to chimps, though.

In any given year, the majority of professional fund managers underperform their benchmark index — a virtual certainty given a limited amount of return to capture and an unlimited amount of fees to charge.

For example, in 2011, 84 percent of U.S. stock fund managers underperformed the S&P 500 index, according to Standard & Poor’s. That’s bad enough, but dig deeper and it gets far worse. It turns out that the overwhelming majority of professional fund managers focused on the minority of stocks that underperformed the market. It takes skill to be that bad.

(Per S&P Capital IQ data, the average stock that rose more than 2.07 percent returned 20.4 percent, while the average stock below that threshold fell 16.6 percent.)

This isn’t rare, and it extends beyond fund managers to Wall Street analysts. According to Bloomberg, “The 50 stocks in the S&P 500 with the lowest analyst ratings at the end of 2011 posted an average return of 23 percent (in 2012), outperforming the index by 7 percentage points.”

Meanwhile, fees make the situation worse. In one report, IBM concluded that global money managers overcharge investors by $300 billion a year for failing to deliver returns above a benchmark index. Vanguard cites data by the Financial Research Corp. showing that the single best predictor of a fund’s future performance is its expense ratio (essentially an annual fee).

A common rebuttal is that, while money managers underperform an index, they are better at managing risk and lowering volatility. But studies have shown that the average mutual fund closely tracks the ups and downs of the overall market.

Some professional managers can beat the market and earn their fees. The majority can’t. If you don’t have the time or inclination to manage your own money, you’re likely to do best buying a passive, low-cost index fund.