This past weekend, I was able to settle in with my family over a great meal and watch one of the best football games I’ve seen in a long time.
By the time dinner was over, halftime was about to start and we had some time to make up for the lack of conversation as all eyes were glued on the nail-biting first half of the Ravens/Broncos game (sorry, Broncos fans)…
What I didn’t on know on Saturday was that I was about to give a long-winded rant covering one of the most obvious realities investors face.
It all started when my brother mentioned his portfolio was up 10% for the year. He started off being happy about it. That changed pretty quickly when I pointed out he could have seen a 60% jump in his return by blindly investing in a single fund on his own.
Like many investors, he was suckered by the promises of a managed fund.
If you have any money in a managed fund that didn’t net over 16%, I’ll ask you the same question: Why pay someone who can’t beat what the S&P 500 returns?
Actively (mis)Managed Funds
First up on the chopping block are the most common professionals you will deal with while investing in any type of fund.
A picture is worth a thousand words, so here’s the latest data from Lipper Analytical Services and Bank of America/ Merill Lynch:
Only 39% of fund managers were able to beat the S&P 500 Index last year.
I’ll at least give them credit for getting close — 15.1% isn’t bad, but you still have to tack on their fees, which will lop off a couple percentage points from your return once everything is said and done.
It is particularly hard to tell exactly how value and core investing did not work…
The financial sector was up 25% and the retail sector was up about 19% in 2012. Both sectors should play a part in these investment strategies.
Dividend stocks had a great year — yet only 21.4% of managers in that category beat the S&P 500 while correlation was incredibly high. How they managed their way to such dismal results is a complete mystery.
For some perspective, over the last 10 years the average number of managers that beat the S&P 500 Index is around 48%. That’s better, but not anything to pay for when you’re forking over your savings to a so-called professional.
The “Stars” are Worse
The funds that demand even higher fees don’t do particularly well, either.
The HFRX, a widely-used measure of industry returns, was up a meager 3%.
And take a look at hedge fund performance for the last ten years:
Over the past decade, hedge funds have averaged a 17% return. As a group, the supposed “masters” of the financial world have returned less than inflation.
All hedge funds aren’t created equal, of course: The top 10% of managers has served up returns of over 30% in the past year; the bottom 30% lost money, often a lot.
If only the top performers were consistent year to year…
Just look at John Paulson, the seemingly clairvoyant investor who made a fortune predicting the housing bubble. His fund lost 17% in the first ten months of 2012, but the year before he posted a massive a 51% fall.
What are You Paying for?
For the privilege of allowing them to underperform with your savings, these fund managers are collecting some sizable fees.
For actively managed funds, the amounts are relatively low, at least. The average expense ratio for actively managed funds was 1.43% in 2011. Anything up to 2.7% can be expected for mutual funds, depending on how the funds are handled and how often managers enter and exit positions.
Hedge fund managers have the most explaining to do to their clients by far. The average annual management fee is 1.5%, and you can expect to lose 20% of any gains. These fees reduce the return from an average hedge fund down about 3.5% to 13.5%.
Simply doing it yourself with bond and index funds would cost about 0.12% to 0.15%. If hedge fund performance continues like this, you could have made more than a hedge fund investor in a single year without paying an “expert” a single cent.
If you did beat 16% in a managed fund, learn the manager’s name and keep an eye on him or her… and get out if this person leaves. You’ve found a diamond in the rough and should stick with them.
If you’re like my brother, you should seriously consider doing it on your own. Max out your 401(k) if you have matching returns. Start using a Roth IRA for the rest of what you can save, and do it yourself.
Simply using index ETFs and index mutual funds for a majority of your account will save you a small fortune over time.
With a bit of patience and knowledge, you’ll be building up your account faster than ever — and outperforming the pros in no time.
For Your Prosperity,
Adam English
for Wealth Daily
