29 May 2007

Fund managers rule!

Ah yes. All fund companies have something to offer you that nobody else has-- funds that will beat the market! Or so they will tell you. You can beat the market with managed mutual funds-- sometimes. To do this, you either need to be lucky or know something that most people don't-- a fund manager or company that consistently outpaces the market indexes.

Some managers are better than others, but nobody consistently beats the market. You have to pick and choose the right funds from the right people, hoping to maximize your chances. But your odds are still not great. When googling on the subject I ran across the following curiosity, courtesy of Vanguard:

So on average, here's how badly the managed funds lose to the market indices (for the 10-year period ending Dec. 2004):

LCV: 0.86%
LCB: 1.82%
LCG: 2.43%
MCV: 3.54%
MCB: 3.04%
MCG: 5.00%
SCV: 1.05%
SCB: 1.10%
SCG: 1.29%

The managed funds fared best in the small cap blend arena, where they still lose 53% of the time (and by an average of 1.1%). Managers do especially poorly with mid cap stocks.

Why? Well, two reasons. One is that fund managers, in general, do not pick winning stocks very well. The second is fees. Huge, enormous fees. Some managed funds do well enough to beat the market, but fees erode the difference (plus some) and the fund is a loser in the end.

Personally my investments are blended between managed and index, but this is not by choice. I would go entirely with index funds if my options allowed it. The managed funds I do have are at least rated well by morningstar and have relatively low fees.

Let this tidbit sink in for a moment. Fund managers are educated, trained, and experienced in stock picking. And according to this chart, it seems they lose to index funds some 3/4 of the time or more. What does that say about building your own portfolio out of individual stock picks? To me it says, "you'd better get lucky." You may win big, but you also may lose-- and the odds are stacked severely against you.

14 comments:

Kevin Gunn said...

Hi Brad --

I'm a big fan of index funds -- and your article does a great job of demonstrating why!

I put up a mini-article linking to you from my pf blog, but since the automatic trackback failed so I wanted to let you know here that I enjoyed your post enough to comment on it and link to it.

I really don't think fund managers (with very few exceptions) ever have much to offer. A really good fund manager who is an expert in his sector may beat the market, but as soon as he does his fund will grow to be too popular to manage easily -- he ends up branching out into areas where he isn't an expert and loses his edge.

Even if the fund manager DOES still beat the market, for his fund to be worthwhile to me he must do much better than the market to meet the return on an index fund simply due to the additional costs associated with actively managed funds.

I think I'll stick with my index funds.

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