No surprise but I tend to look at 20 year timeframes which always takes me back to Brk.
Don’t buy financial products! 75% of mutual funds underperform the market. Incompetence? No, the Law! The law? Which Law?
The Power Law Distribution! Pareto’s Law!
The Captain
Underperformance of the average active fund is just the law of basic arithmetic.
Because, for the entire market we must have
- Market Portfolio = Active Portfolios + Passive Portfolios (by definition)
then - Market Portfolio Average Returns = Weighted Average of (Active Portfolio Returns + Passive Portfolio Returns)
but - Passive Portfolio Returns = Market Portfolio Average Returns (by definition of passive management)
so - Active Portfolio Returns = Market Portfolio Average Returns
must be true as well for #2 to hold.
Active management costs being greater than passive management costs then reduce average active returns below average passive returns.
But don’t take my word for it, see below from Nobel Prize winner William F. Sharpe (as in the Sharpe Ratio).
See Sharpe on active vs passive returns:
If “active” and “passive” management styles are defined in sensible ways, it must be the case that
(1) before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar and
(2) after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar
These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication and division. Nothing else is required.
Interestingly enough, this year, some of them have beat the market. More of them than generally expected. So watch next year as the marketing machines ratchet up into high gear and highlight their one year performance in an attempt to snag new customers and their money.
The most highly valued skill of a financial advisor isn’t investment management or stock selection. It’s the ability to present plausible and believable excuses for under performance to the clients complaining about high fees.
intercst
Another “skill” is the overuse of the word “fiduciary”. They explain it over and over again … because I am a fiduciary, I MUST do what’s good for you. Never mind that over the medium or long term I cost you far more than necessary, and never mind that over the medium and long term I almost always underperform, and never mind that a simple low cost index fund is VERY likely to outperform AND cost much less.
The other thing they never ever touch upon is account management in retirement. Specifically the costs of it. Even if you have a say $2M total, and they manage it all for a mere 1% (usually it’s a bit higher than 1% for that size account), then assuming you are withdrawing a prudent 4% a year, they are getting 1% out of the 4% which means they take A FULL 25%, yes one full quarter, of your total annual income just to manage your account!!! That’s usually more than this person will pay in taxes.