Professional fund managers are responsible for investing billions of dollars on behalf of investors. They are often highly educated, have years of investing experience, and are paid well for their skills and expertise. But the truth is that most of them are not worth the fees they charge.
You don’t need a college degree or any special knowledge to outperform the vast majority of actively managed mutual funds. A simple strategy can beat about 88% of them. It’s a strategy that Warren Buffett bet half a million dollars on in the hopes that he could beat any hedge fund manager over 10 years.
He won the bet.
All you have to do is buy a S&P 500 index fundas the Vanguard S&P 500 ETF (NYSEMKT: VOL)and you can expect better long-term returns than most active mutual funds.
Why 88% of active large-cap funds can’t beat a simple index fund
Global S&P publishes its SPIVA (S&P Indices Versus Active) dashboards twice a year. The dashboard compares the performance of active mutual funds (after fees) to relevant S&P benchmarks over one, three, five, 10 and 15 year periods. It found that 88% of active large-cap funds have failed to beat the S&P 500 over the past 15 years, as of the end of 2023. Even over a shorter three-year period, about 80% failed to beat the benchmark index.
Several factors are behind such disappointing results for active funds as a group.
First of all, it is important to consider how does the stock market workThere is always someone on each side of a transaction; for every buyer, there is a seller. And among large-cap stocks, the people who buy and sell stocks are primarily institutional investors. In other words, a fund manager usually sells his shares to another fund manager. They can’t both be right.
Given that large institutions represent the bulk of the market, the odds of outperforming the market as an active fund manager may be little better than 50/50. But the second factor significantly diminishes the returns passed on to investors in actively managed funds.
Fund managers, their teams, and the institutions they work for all need compensation. This means that mutual fund investors have to pay fees. The most common is the expense ratio, which represents a portion of assets under management. These fees can well exceed 1%. This means that the fund manager must outperform the market based on the fees they charge their clients just to break even. And it’s a lot harder than just beating the market by a few basis points.
As a result, the percentage of actively managed mutual funds that outperform the S&P 500 in any given year is only about 40%. And very few of them are able to beat the market consistently enough each year to come out on top over the long term.
Reduce your “cost of participation”
If you want to outperform the average investor, the key is to reduce what Vanguard founder Jack Bogle called “the cost of participation.” These are the costs you have to pay to invest your money.
It has become easier and less…
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