Monday, January 12, 2009

Active Management Strategies Are Generally An Expensive and Losing Proposition vs. Index Funds

From Vanguard founder John Bogle's WSJ article last week "Six Lessons for Investors":

"Owning the market remains the strategy of choice. Such a strategy guarantees a return that lags the market return by a minuscule amount, and exceeds the return captured by active equity-fund managers as a group by a substantial amount. Why? Because the heavy costs incurred by investors in actively managed equity funds can easily amount to 2% to 3% annually. Typical expense ratios run from 1% to 1.5%; the hidden costs of portfolio turnover often come to 0.5% to 1.0%; a 5% front-end sales load, amortized over a holding period of five to 10 years, adds another 0.5% to 1.0% per year in costs.

As a group, investors are by definition indexers. (That is, they own the entire market.) So indexing wins, not because markets are efficient (sometimes they are, sometimes they are not), but because its all-in annual costs amount to as little as 0.1% to 0.2%.

Indexing won in 2008 by an especially wide margin. Low-cost, low-turnover, no-load S&P 500 index funds outpaced nearly 70% of all equity funds, and (admittedly a fairer comparison) more than 60% of all funds focused on large-cap U.S. stocks. This continues the pattern -- with some variations -- that goes back to the start of the first index fund 33 years ago. The bond index fund did even better. Its return of 5% for 2008 outpaced more than 80% of all taxable bond funds.

In sum, active management strategies as a group lose because they are expensive. Passive indexing strategies win because they are cheap."


At 1/12/2009 11:39 AM, Blogger PeakTrader said...

The stock market is a very steep learning curve. However, I noticed, when you wait for excellent opportunities (e.g. the market or a stock), they'll eventually show up. The hardest part is passing-up very good opportunities, because they're not good enough, and doing nothing for long periods of time (in the case of Warren Buffett, doing nothing with a lot of cash for years). Moreover, I noticed, technical indicators are more reliable at market bottoms than tops. Furthermore, when markets rise on negative news, that indicates a further rise, and vice-versa, since it's the information we don't know that's most important. It's all about probabilities and portfolio management. George Soros stated: "It's not whether you're right or wrong that's important, but how much you make when you're right and how much you lose when you're wrong." However, you can be right well over half the time also, waiting for excellent opportunities

At 1/12/2009 4:13 PM, Blogger spencer said...

If investors are generally better off investing in an index fund why is it not a major inefficiency and waste of resources for the market to support a major money management industry?

How would this compare with government waste?

At 1/13/2009 1:50 AM, Blogger Plamen said...

And yet, Bogle's Vanguard does offer:
VAAPX - "tactical allocation strategy")
VPDFX, VPGDX, VPGFX - "managed distribution policy"
VPCCX - "fundamental, research-driven approach that seeks to identify companies with long-term potential overlooked by the market"
VPMCX - "large and midsize U.S. companies the fund’s advisor believes have above-average earnings growth potential not reflected in their current market prices"
VASVX - "selects stocks of companies considered undervalued, after extensive evaluation of their prospects through a traditional, fundamental approach"
VSEQX - "uses computer-driven valuation models to assess criteria such as earnings and cash flow"
VSTCX - "uses a quantitative, computer-driven stock-screening process"

It's hard to be taken very seriously when you are a salesman, and a hypocritical one at that.

At 1/13/2009 10:19 AM, Anonymous Anonymous said...


While I agree it is somewhat hypocritical for Vanguard to have actively managed products, this is not a reflection of Bogle.

If you read any of his writings, he blasts these products. He is no longer running the show at Vanguard and the new leadership has deviated from the founding Bogle philosophy.

At 1/13/2009 11:00 PM, Blogger Plamen said...

Anne, while I take Wikipedia with the due level of reasonable doubt, it does state that Bogle is still very involved in Vanguard. I'd be curious to see any links you have that may testify to the opposite.


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