Thursday, May 29, 2008

Index Funds Consistently Outperform Actively Managed Mutual Funds

1. The S&P 500 Index consistently outperformed 98% of mutual fund managers over the past three years and 97% over the past 10 years, ending October 2004. In two 30-year studies, the S&P 500 outperformed 97% and 94% of managers. In addition, only about 12% of the top 100 of managers repeat their performance in the following years. Therefore, it is not possible to consistently pick next year’s hot mutual fund manager.


2. Over fifteen years to 1998, on a pre-tax basis the Vanguard S&P 500 index fund outperformed 94% of general equity mutual funds and 97% on a post-tax basis. The post-tax average difference in annual performance was 4.2%.

~From Common Sense on Mutual Funds, by John Bogle

Bottom Line: If you scored at the 97% level on the LSAT (score of about 169-170), I think you'd feel pretty good, especially if you didn't even have to study too hard (like index investing). On the other hand, if you paid a test preparation company thousands of dollars (like a mutual fund manager or investment advisor) and got a score far below the 97% percentile (which you pretty much could have gotten on your own for free), I think you'd feel pretty bad.


At 5/29/2008 11:40 PM, Anonymous Anonymous said...

Dunno 'bout that. Fifteen years ending in 1998 is pretty old data.

Taking a quick check of funds I own in my 401K, they have these ten year annualized returns for 1998 to 2008:

Dodge & Cox Balanced up 8.76%
Davis NY Venture up 6.82%
Fidelity Mid-Cap up 9.93%

By comparison, the classic index fund, Vanguard 500 Index is up 4.12%

The internatioaal funds I own in my 401K have done even better:

Fidelity Diversified Intl up 11.27%
Harbor Intl up 11.93%

These numbers are from

At 5/30/2008 8:00 AM, Blogger Malachi said...

fred, I believe you are comparing apples and oranges. The S&P 500 is a large cap fund. Balanced funds and mid-cap funds are investing in assets outside of its 'investment universe'.

To compare apples to apples, compare your mid-cap managed fund to Vanguard's mid-cap index fund, which is up 10.32% over the past 10 years.

At 5/30/2008 8:11 AM, Anonymous Anonymous said...

Isn't that why most financial experts recommend diversification?

With ten mutual funds and 4 bond funds in my 401(k), I've had around 10% annualized returns over the last 10 years. Well, let’s not count this year, yet.

Comparing one mutual fund manger to the S&P 500 is not a fair comparison unless an investor only has one mutual fund. Perhaps a better comparison would be comparing a cross-section of the middle 500 mutual funds to the S&P 500.

At 5/30/2008 8:24 AM, Blogger Colin said...

This also leaves out the fact that actively managed funds have higher fees -- so even if performance between the two is exactly the same you are still worse off with the actively managed fund.

At 5/30/2008 9:31 AM, Anonymous Anonymous said...

Not convinced, Fred? Try reading "A Random Walk Down Wall Street" by Burton G. Malkiel. Incidentally, your international funds likely contain significant currency gains due to the drop in the dollar over the past several years, which has boosted their returns. Of course, these gains can easily be reversed with a strengthening dollar (assuming your funds are not hedged for this).

At 5/30/2008 9:55 AM, Anonymous Anonymous said...

"Over fifteen years to 1998, on a pre-tax basis the Vanguard S&P 500 index fund..." Looks like the same apple to me.

Show your math. For the funds I've shown the return is net of fees.

Active international funds can do currency hedging. Read the prospectus to find out if your funds do. Index internatioanl funds don't hedge. That's part of why I dropped Vanguard's international index, VGTSX, last year.

For the rest of it, who am I supposed to believe? You or my lying eyes?

I have used index funds in the past and may again in the future, but not now.

At 5/30/2008 11:46 AM, Blogger Malachi said...

fred, what is your method for picking winning fund managers?


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