Finding the Elusive 15%

From Dana Nibby: "If index funds beat 85% of all other mutual funds, and there are 7000 mutual funds, this means 1050 funds (15%) beat or match index funds. What’s the time horizon for the 85% figure? And . . . of the 1050 funds which beat or match the index, are these largely the aggressive growth funds?"

When the market is going up, it’s the aggressive growth funds that tend to do better than average. When it’s going down, it’s the conservative funds that do.

Most funds, over time, do about average. It’s VERY hard consistently to do better. But then you have to subtract the sales loads many funds charge and annual expenses. Index funds have no loads and charge tiny expenses and so have a huge advantage. (In the investment derby, I’m fond of saying, the fund with the lowest expenses is the horse with the lightest jockey.)

As an individual stock picker, this is also your advantage in paying no annual expenses and seeking a broker that charges very slight commissions. (Counter-balancing this advantage is the amount of time and worry stock-picking can take, and the fact that you are pitting your part-time skills against some highly skilled, impressively equipped, full-time competitors.)

The longer the time horizon, the better the index funds will do. Why? Because of the 15% (or 25% — whatever) of actively managed funds that do manage to beat the market by enough to more than overcome their expense handicap in any given year, study after study shows that few do so consistently; i.e., the ones in the 15% this year may do poorly next year.

(Index funds also subject you to less tax, because they tend to buy and hold. In a taxable account, that gives them yet another strong edge over actively-managed funds.)

So if you take the mutual fund route, you should not feel dumb betting on a couple of index funds rather than trying to find tomorrow’s outperformers.

Monday: The Money or the Miles – Part II