Weak Arguments for Indexing

In the New York Times, Jeff Sommer writes of the difficulty mutual funds have in consistently outperforming the stock market. He highlights a recent study by Standard & Poor:

The S.&P. Dow Jones team looked at 2,862 mutual funds that had been operating for at least 12 months as of March 2010. Those funds were all broad, actively managed domestic stock funds. (The study excluded narrowly focused sector funds and leveraged funds that, essentially, used borrowed money to magnify their returns.)

The team selected the 25 percent of funds with the best performance over the 12 months through March 2010. Then the analysts asked how many of those funds — those in the top quarter for the original 12-month period — actually remained in the top quarter for the four succeeding 12-month periods through March 2014.

The answer was a vanishingly small number: Just 0.07 percent of the initial 2,862 funds managed to achieve top-quartile performance for those five successive years. If you do the math, that works out to just two funds. Put another way, 99.93 percent, or 2,860 of the 2,862 funds, failed the test.

Sommer writes that this is evidence in favor of investing in passively-managed index funds. Sorry, but I don’t see the connection. Just because a fund manager doesn’t beat the market every quarter is hardly a reason to ditch active management altogether.

If an investor is comfortable with investing in an index fund, sure, go right ahead. Some investors simply don’t care about beating the market, and I understand that mindset. But if you’re going to try and beat the market, which I think is the smart thing to do, then you have to realize that you’re not going to do it all the time. That’s unrealistic. The most that you can hope for is that you’ll do it over the long term.

Posted by on July 21st, 2014 at 10:46 am


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