A BETTER WAY TO INVEST

Welcome to Investing With Comfort. I’m Richard E. Evans, investment author and analyst.

The main point of this blog is to show anyone with money in the markets a low-stress way to outperform Wall Street.

It’s not as hard as it sounds. Certain index funds–especially those that cost $5 out of every $1,000 invested–routinely outperform actively managed funds and private portfolios. Let’s look at some examples from my latest book, Investing With Comfort:

The venerable S&P Dow Jones company issues a report called SPIVA, which is short for Standard and Poor’s Indices Versus Active. It’s an authoritative, ongoing comparison of actively managed performance versus relevant indexes. Here’s what SPIVA reports on the results of a broad-market index versus the average of all domestic stock funds over three time periods, each ending on December 31, 2015:

• The three-year record shows that 81 percent of actively managed funds failed to beat the S&P Composite Index of 1500 stocks, which covers 90 percent of the U.S. stock market.
• The five-year record shows that 88 percent of actively managed funds failed to beat that index.
• The 10-year record shows that 83 percent of actively managed funds failed to beat that index.

So whether you look at three years, five years, or 10 years, more than 80 percent of actively managed funds failed to outperform a broad-market index. And last year? To pick one example, the Vanguard Total U.S. Stock Market Index Fund turned in a scorching 18.07% return.

“But,” someone may say, “those special index funds didn’t beat all the actively managed funds. So I’ll just buy the ones that beat the indexes.”

Lots of luck. What you’ll find is that there’s little to no consistency from year to year; last year’s winners are likely to be this year’s losers. Here’s how bad it gets:

Two, then none.
In 2014, researchers at S&P Dow Jones Indices studied the performance of of 2,862 actively managed mutual funds over a five-year period starting in 2010. These were funds that were in the top quarter of performance (called a “quartile”) in March of 2010. Want to guess how many of those high-fliers stayed in the top quartile for the entire 5-year period?

The answer is two. That’s two out of 2,862. Imagine the odds against picking those two in 2010. (I hope someone reading this calculates the odds. Common sense tells me they must be astronomical.)

And it gets worse. The researchers also looked at how many of the 2,862 funds stayed in the top quartile through six years. The answer this time: none. One of the two top-quartile funds after five years plunged to the bottom quartile in the sixth year, while the other one sank to the third quartile.

But suppose you were lucky enough to buy one of those funds in 2010. What then? Well, if that fund was doing well, it’s likely that the broad-market index funds were also doing well. So your gain over their performance would probably have been no more than a couple of percentage points, depending on when you sold.

Aside from earning only a small net gain over an index fund, there’s another issue you would have had to confront: when to sell, always a tough decision. As the outperforming fund started to turn down, you may not have immediately sold. Having done well with the fund, you may have decided to hang in there, even as the fund sank lower and lower. In that case, by the time you finally sold, your gain may have turned into a loss.

Which leaves us with the conclusion that human nature is yet another reason to prefer broad market index funds to owning individual stocks or funds.

In future posts, I’ll explain why broad market (and total market) index funds typically outperform actively managed funds and portfolios. I’ll also review a strategy for comfortable investing and comment on which types of index funds are likely to give you the best results.

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