Even the best fund managers can’t beat the market

Half of all the institutional money is invested in simple indexing strategies. The most sophisticated and successful money managers of all time advocated index investing very early on. Already in 1990, Peter Lynch and in 1996 Warren Buffet believed that investing in index funds is the best way for most investors to own stocks.
Therefore the foundation of your overall and well diversified investment portfolio should consist of a no-nonsense selection of low-cost, tax-efficient index funds that give you the highest probability of long-term success. Your core money should be handled in a serious way, not like chips on a roulette table.
Indexing and owning individual stocks are not mutually exclusive activities. You can do both, but don’t bet on individual stocks before you have created a solid portfolio designed to grow your wealth during the good times and protect it during the bad. And this can be easily done with a selection of index funds.

3 out of 4 fund managers despite collecting high fees underperform their benchmark each year. Over a period of a decade or more, over 90% of them do! This includes even the best of the best. None (!) of the 5 Morningstar 2010 “fund managers of the decade” were capable to beat the market for the past 10 years. In fact, the best manager of them all, Bruce Berkowitz of the Fairholme Fund became the worst.

Here are the 4 primary reasons why smart (or not so smart) fund managers deliver below par performance:

1. Markets are efficient.
Rational, self-interested investors quickly price all relevant information into publicly traded securities, as soon as it becomes available. Beating the market is difficult under these circumstances, especially today with all the information immediately available.

2. Fund fees and expenses eat into returns.
The managers don’t have to just beat the market. They do have to cover all their cost first before they are break-even.

3. Mutual funds have to hold cash to meet redemptions.
Not being able to fully invest influences performance.

4. All hot sectors turn cold eventually.
Especially when a fund invests in a narrow sector they ride the wave only as long as it lasts. Waves are not endless.

Sven Franssen