Active Fund Management Is A Loser's Game
The following is a summary of the latest scorecard's findings:
- For the five years ending March 2012, only 5.23% of large-cap funds, 5.46% of mid-cap funds and 5.14% of small-cap funds maintained a top-half ranking over five consecutive 12-month periods. Random expectations would suggest a rate of 6.25%.
- Looking at longer-term performance, 5.97% of large-cap funds with a top-quartile ranking over the five years ending March 2007 maintained a top-quartile ranking over the next five years. Only 4.35% of mid-cap funds and 15.56% of small-cap funds maintained a top-quartile performance over the same period. Random expectations would suggest a repeat rate of 25%.
For example, with a minimum $10,000 investment in the Vanguard S&P 500 Index Fund Admiral Shares, the fund's expense ratio is only 0.05% - that's just 1/20th of 1%, or $5 per $10,000 per year (that's basically free). The average annual expense ratio for an actively managed large-blend mutual fund is about 1.22%, or more than 24 times higher than the expense ratio of the Vanguard fund. And in almost all cases, those actively managed funds will underperform the benchmark indexes like the S&P500. Over long periods of time, the S&P 500 has consistently outperformed something like 94-97% of actively managed mutual funds, which as the article above points out, is a "loser's game."
When the choice is between: a) passively-managed index funds with expenses that are almost zero, and with higher returns on average than actively-managed funds over long periods of time, and b) actively managed funds with very high management fees and lower returns than passive funds over time, it is almost a mystery why active funds can survive and remain so popular?