I’ve looked high and low and I’ve finally found it!
‘It’ is the source document for all of the commentators who have (rightly) suggested that Index Funds outperform actively managed Mutual Funds.
And, it is produced by Standard & Poors who publish the major Indices themselves:
The Standard & Poor’s Index Versus Active (SPIVA) methodology is designed to provide an accurate and objective apples-to-apples comparison of funds’ performance versus their appropriate style indices, correcting for factors that have skewed results in previous index-versus-active analyses in the industry.
And, here are their most recent findings (they are in the process of rebuilding their databases for 2008):
Indices continue to exceed a majority of active funds. Over the past three years (and five years), the S&P 500 has beaten 65.7% (72.2%) of large-cap funds, the S&P MidCap 400 has outperformed 68.6% (77.4%) of mid-cap funds, and the S&P SmallCap 600 has outpaced 80.2% (77.7%) of small-cap funds.
The solution is simple: don’t buy any of the funds in the bottom 65.7% 🙂
Great! But how?
Well, Mutual Funds are rated by Morningstar as 5-Star (best performance) to 1-Star (worst performance) so, we should simply buy 5-Star funds, right?
Wrong … because Morningstar – even though it is the best / most highly regarded of all the Mutual Fund ratings services – is only based upon past performance, which is NO guide to how any rated fund will perform in the future as this independent research review found:
They find, for example, that five-star US equity funds significantly outperform one-star funds only 37.5% of the time; at the same time, these same funds significantly outperform three star-funds 18.75% of the time. It is clear then that—compared to a random walk–Morningstar’s ratings system offers no added value in terms of predicting mutual fund returns.
If the best can’t do it, do you think you can?
And, do you want to leave your financial future to a ‘random walk’ in the financial park?!
So, why do funds tend to fall short of the ‘market’?
Well, partly because of a tendency to trade stocks too much (the fund managers like to ‘look busy’) and partly because of fees … Mutual Funds tend to fall short of the market by the amount of the fees that they charge!
The ‘small moral’ of the story: invest in the Indices …
… find a low cost Index Fund that will do the job; by as much of it as you want and hold it for the long term.
Of course, the ‘large moral’ of the story is: who the hell is content with 11.9% maximum long-term stock market index returns, anyway 😉