The Secret Fund Managers Don’t Want You to Know

by Jason Unger

If your investments are being actively managed, your fund manager is likely keeping a big fat secret from you.

He doesn’t want you to know it, because he’d lose your business.

But it’s costing you money every day — your money.

The secret? Most active managers can’t even top the index they’re trying to beat.

Index Funds Outperform Actively Managed Funds, Again

According to new research from Standard & Poor’s, in the past 5 years, more than 71% of large-cap fund managers couldn’t beat the S&P 500 index they’re benchmarking against.

From the MarketWatch report:

The failure of active management is replicated across almost all categories, not only U.S. stock funds but also bond funds and even emerging-markets funds. What’s more, those numbers are similar to the previous five-year cycle.

From the close of Dec. 31, 2003 to Dec. 31, 2008, the S&P 500 dropped 18.8% — but that was still enough to beat 71.9% of U.S. actively managed large cap funds, according to S&P Index Services.

“We consistently see that once you extend time horizons to five years, the majority of active managers are behind their benchmarks,” said Srikant Dash, global head of research and design at S&P.

We’ve talked plenty about index fund investing before, and how even if an active fund outperforms the index, fees will likely eat up the difference.

There’s a reason why VFINX, the Vanguard S&P 500 index, is one of the largest mutuals fund in the world (disclaimer: I invest in it). It’s got a low expense ratio (0.15%) and it invests nearly all of its assets in the stocks that make up the S&P 500.

But your fund manager doesn’t want you to know that you’re paying more and getting less. He doesn’t want to tell you that a nearly automated process can beat his “skills” in fund management.

Imagine a salesman telling you that you could get a better quality product for less money from his competitor. It would never happen.

If you’re investing for the long-run, don’t listen to Jim Cramer. Keep more of your own money.

{ 6 comments… read them below or add one }

The Weakonomist April 23, 2009 at 8:34 am

I’ll always remember a mutual fund commercial that said “70% of our funds met or beat their index”. Is that something to brag about? I’d be ashamed of such poor performance. I could start a company tomorrow that does better than that.

Louis April 23, 2009 at 12:52 pm

Great post. If you compare the actual dollar amount you pay in fees to an actively managed fund to an index fund over a 10, 20, or 30 year timeframe, the difference in most cases is astounding.

I would suggest that once people decide to invest in index funds, they should diversify across index funds, not just the S&P 500. Have in your mix a small company index, an international index, and depending on risk tolerance, an emerging markets index.

Jason Unger April 23, 2009 at 1:01 pm

Yeah, that’s a great point — an index fund by its nature is not necessarily going to be diversified, especially if it only targets one sector.

Of course, you could always go The Lazy Investor’s path — own something like three indexes: Total Stock Market, Total International, and Total Bond Market. You’d just have to allocate them correctly.

Bret April 27, 2009 at 4:47 pm

Weakonomist,

The company that claims 70% of their funds met or beat their index is T. Rowe Price.

Actually, I think that’s a lot to brag about, since 70% of other funds fail to meet their averages. And, that doesn’t count all of the dog-funds that got buried by a merger. If you really could start a company and beat the averages 70% of the time, you’d be pretty wealthy. Since most pro fund managers can’t do this, I’d say it’s a long-shot for you.

Just for disclosure, I invest with T.Rowe Price and have been happily beating the averages for a number of years now. I sure hope it continues, since the averages aren’t doing so hot. I know it’s pathetic, but I’m happy to have lost less than the S&P.

Phil December 30, 2009 at 2:01 pm

You should be aware: 70% of their *existing* funds beat the average. The rest of them got shut down. Its called “survivorship bias”.

Steve September 12, 2010 at 11:50 am

So Phil – What are the names and tickers of the funds T. Rowe Price has closed? I’ve been with them for 12 years and I can’t think of a single one.

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