Investing

How to Beat the Fund Managers in 1 Easy Step

Fund managers are talented financial experts who oversee all the investments in a mutual fund. Most adults in the United States own shares in at least one mutual fund. And why not? It’’s an easy way to diversify your portfolio, and you have a pro managing your money for you. In fact, fund managers are usually brilliant people that have access to information you can only dream of.

The reality is that if you own a mutual fund, you”re probably getting screwed. That’’s right, over the long haul, roughly 80% of mutual funds underperform the average market return. Don”t believe me? Let’’s just take a look at the most famous mutual fund around: Fidelity Magellan. Once headed by the famous Peter Lynch, Magellan was the biggest mutual fund for some time and grew all the way to $100B by the end of last century. Today it holds just a little over $45B in net assets. The chart below illustrates the performance of the Magellan fund vs the Stock Market.

The blue line is the world’’s most famous, and once most popular, mutual fund. The red line is the S&P 500 index (aka, the stock market). It doesn”t take a genius to realize that if you bought shares in the Magellan fund at anytime over the past 25 years, you missed out on a lot of money. Not only that, but you also paid someone to give you those mediocre results.

Okay, okay, Fidelity Magellan is only the world’’s most well known mutual fund, it’’s not the best performing. After all, there are a few mutual funds that do beat the market year after year for a prolonged period of time. Take a look at the Third Avenue Small Cap Value Fund (TASCX). It’’s been beating the S&P 500 for the past seven years straight. Impressive!

Here it is over the past 4 years. Again, the mutual fund is in blue and the market index is in red. Now you”re telling yourself: “I wouldn”t mind paying this fund manager if he can beat the market for me!” Wrong! You should mind! The only reason these results look so desirable is because we”re comparing this fund to the wrong benchmark. We”re looking at a Small Cap Value fund, and we”re comparing it to the overall market. Instead, we should be comparing it to a Small Cap Value index, it’’s only fair. For this, we”ll choose Vanguard’’s Small Cap Value ETF (VBR) which tracks the performance of the MSCI US Small Cap Value Index. Here are the results:

Against the correct benchmark, it’’s clear that the mutual fund underperforms, again. By now I think you get the idea, so I”ll leave you with the simple one step program to beat mutual fund managers.

How to beat the fund managers: Invest directly in the market by buying an index tracking ETF.

Don”t worry, I”ll explain exactly why this single step is a better way to invest in the stock market than a mutual fund…. in the next article. In the mean time, here are some quote from investment experts.

 

“[Most investors] would be better in an index fund.” Peter Lynch, ex-fund manager of Fidelity Magellan

“The S&P index benchmarks outperformed their active peer funds in all nine Morningstar style boxes over the past ten years.” Gus Sauter, Chief Investment Officer, Vanguard, comment made in 2005