Most investors use brokers or financial advisors.
Most brokers and financial advisors justify their fees by claiming that they can "beat the markets."
The most common way they try to "beat the markets" is by picking actively managed mutual funds that will do so.
This should not be very hard to do. After all, the fund manager of a simple index fund that has as its benchmark the S & P 500 index, has few options. He or she must hold all of the securities in the index. There is no discretion.
The active fund manager can select those companies within the index that he believes will outperform others. He can also dump underperforming stocks like a hot rock.
You would think the playing field is not level. The active managers should clobber the index funds.
You would be wrong.
The Morningstar database lists 725 mutual funds that have a "best fit index" with the S & P 500.
The year-to-date (through September 30, 2007) return of the S & P 500 index was 9.13 percent.
Of the 725 funds that should have equaled or exceeded these index returns, only 188 managed to do so.
74.07 percent of these funds underperformed a simple S & P 500 index.
The average year-to-date return of all 725 funds was only 7.96 percent.
In The Smartest Investment Book You'll Ever Read, I recommended four low-cost index funds portfolios that I believe are appropriate for most investors. The one with the lowest risk has 80 percent of its portfolio in bonds and only 20 percent in stocks. The year to date return of this portfolio (through September 30, 2007) was 5.28 percent. It outperformed 96 of these actively managed funds (which have 100 percent exposure to the stock market), with far less risk.
So what's an investor to do?
You could continue to rely on your broker or financial advisor to pick actively managed mutual funds that will "beat the markets." However, understand that you have only a 1 in 4 chance of being right. And the odds are much worse over the long term.
Or you could dump your broker or advisor and "buy the market" by purchasing low cost index funds representing an asset allocation appropriate for you. If you do this, you are 100 percent certain to capture market returns (after deduction of the low fees charged by these funds) because you are investing in the market.
It seems like a no-brainer to me.
Will this be a wake-up call to investors?
The views set forth in this blog are the opinions of the author alone and may not represent the views of any firm or entity with whom he is affiliated. The data, information, and content on this blog are for information, education, and non-commercial purposes only. Returns from index funds do not represent the performance of any investment advisory firm. The information on this blog does not involve the rendering of personalized investment advice and is limited to the dissemination of opinions on investing. No reader should construe these opinions as an offer of advisory services. Readers who require investment advice should retain the services of a competent investment professional. The information on this blog is not an offer to buy or sell, or a solicitation of any offer to buy or sell any securities or class of securities mentioned herein.