Those eye-popping returns featured in the ads for the mutual fund industry are very attractive. Why try to match the market when it looks like you can smash the market by investing in the right mutual fund?
Unfortunately, things are not always as they appear.
At a talk to the Financial Industry Regulatory Authority, John Bogle, the founder of Vanguard, shared some startling data.
Returns for the S&P500 from 1980 – 2005: 12.3%
Returns of the average fund from 1980 – 2005: 10%
And how well did investors do in that time period? No one knows for sure, but it appears they did much worse than 10%.
As an example of how bad investors might have fared in that time period, Bogle looked at the returns of the 200 funds with the largest cash inflows from 1996 – 2005. Those funds reported average returns of 8.9% for the period. The dollar-weighted returns (the returns shareholders actually earned) were an abysmal 2.4% - just 25% of what the funds themselves returned.
Of course the fund industry will say that it’s the investors fault for not staying fully invested during that time. Bogle has a different view however. He sites 3 main reasons that the mutual fund industry plays a big role in the dismal returns actually earned by investors.
1. “It was we in the fund industry who created those new funds that were to create such havoc for investors. As the market soared ever higher, we introduced those 494 brand new “New Economy” funds. Only a precious few of the major fund marketers had the courage to stand firm against the market madness, and forbear from creating and offering such funds.
2. When we had funds whose performance turned “hot,” we marketed them aggressively. Our public relations departments were willing co-conspirators with the press in establishing interviews with our “star” portfolio managers, many of whom, inevitably, turned out to be comets.
3. The higher a fund’s performance soared, the more we advertised our returns. Example: In March 2000, the month the market hit its high, there were 44 equity funds that advertised their performance in MONEY magazine. The average advertised annual return was +86 percent. Imagine! (During the next three years, these funds were to plummet by 39 percent.) Unsurprisingly, after the fall, in the October 2002 issue ofMONEY there were only four funds that did so.”
We have two lessons here:
1. Invest for the long term. Market timing does not work.
2. The “eye-popping” returns featured in the ads for actively managed funds are very misleading. The overwhelming evidence out there indicates that investors would be much better off investing in low cost, passively managed index funds.
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