Mutual funds generally fall into one of two camps: On the one hand, there are actively managed portfolios that are run by stock pickers who attempt to beat the broad market through skill and strategy. Then there are passive funds, which are low-cost portfolios that simply mimic a market benchmark like the S&P 500 by owning all the stocks in that index.
The question for individual investor is, which one to go with.
On Thursday, yet more evidence surfaced demonstrating just how hard it is for actively-managed funds to win.
S&P Dow Jones Indices releases a report every six months which keeps track of how well actively-managed funds in various categories perform against their particular benchmark. The “U.S. S&P Indices Versus Active Funds (SPIVA) Scorecard” came out yesterday and told a familiar tale: active fund managers struggled mightily.
Last year only 14% of managers running funds that invest in large U.S. companies beat their benchmark. That means 86% of professionals who get paid to beat the market lost out to novices who simply put their money in a fund that owned all the stocks in the market.
It’s further proof that the genius you invest your money with isn’t that smart — or isn’t smart enough.
It’s not that professional stock pickers don’t have skills. The problem is, actively managed funds come with higher fees than index funds, often charging 1% or more of assets annually. And those fees come straight out of your total returns.
What this means is that even if your fund manager is talented enough to beat the market, he or she would have to consistently beat the market by at least one to two percentage points — depending on how much the fund charges.
A similar rate of futility appeared even if you extend the investing horizon to five or ten years. If you look at all U.S. stock funds, 77% of them lost out to their index.
International funds fared no differently. Only 21% of global active managers enjoyed above-index returns over ten years. Active managers also fell short in most fixed-income categories, for instance 92% underperformed in high-yield bonds.
One area where active managers have outperformed over the past one, three, five, and 10 years is in investment-grade intermediate-term bonds.
MONEY has warned investors against indexing the entire U.S. bond market because so much of such fixed-income indexes are made up of government-related debt, which happens to be very expensive right now.
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So where should you put your money?
Look to MONEY’s recommended list of 50 mutual and exchange-traded funds. With a few of our “building block” funds you can cover achieve broad diversification in domestic and foreign stocks and bonds.
To be fair, our list also includes several actively managed funds, which can help you customize your portfolio by tilting toward certain factors that tend to outperform over time, such as value stocks.
Still, the bulk of your portfolio belongs in low-cost index funds.