Dear Mr. Market:

It has been said that eight of the most expensive words in the business world are: “Because we have always done it that way!”  How often have we heard these words in our personal or professional life?  Where would we be as a country if we embraced this phrase?  Isn’t it safe to say life as we know it would not be the same if generations before us didn’t challenge the norm and truly “think outside the box”?

For decades Wall Street has fought change and attempted to maintain a shroud of secrecy with investors.  Mr. Market has become very skilled at pushing aside information and research that questions the norm and in many cases proves him completely wrong.  In this article we will look at some facts and figures that simply can’t be argued with or twisted into something that they are not.  If you are an investor who owns any mutual funds you need to read this!

Mutual funds continue to be one of the most popular investment vehicles available to investors today.  According to the Investment Company Institute’s official survey there is over $13.857 trillion dollars currently invested in mutual funds.  To put this figure in perspective that is more than many country’s entire market cap!  With this much invested in mutual funds the next obvious question would be how are these funds performing for investors?  Are they still a viable investment or are investors simply doing what they have always done and not exploring better options?

Domestic equity markets have posted some very impressive returns over the past 12 months with the S&P 500 coming in over 25%.   If you had invested in an S&P 500 Index fund you would have enjoyed these positive returns however many investors are chasing returns and looking for more.  The issue is when you look at Actively-Managed mutual funds like American Funds, Janus, MFS, T Rowe Price and Dodge and Cox just to name a few.  These funds are marketed with huge upside as they have either an individual or team of professionals driving the investments within the fund.  From the impressive marketing pieces investors assume that these mutual fund companies will deliver impressive returns, however, this could not be any further from the truth for the vast majority of them.

Here are some eye opening statistics from this years SPIVA (Standard & Poor’s Indices Versus Active) report.  The information they provide is designed to provide an accurate and objective apples-to-apples comparison of funds’ performance versus their appropriate style index.

• Last year 59.58% of Large-Cap funds, 68.88% of Mid-Cap funds and 64.72% of Small-Cap funds underperformed their respective benchmark indices! When looking at 3-year and 5-year time frames the figures are even less impressive. All domestic equity categories trailed their benchmarks over these time frames.
• If you look at all domestic equity funds (Large, Mid and Small Cap) and compare them to the S&P 1500 Composite, 78.90% underperformed on a 3-year basis and 72.14% on a 5 year time frame!
• Below are the numbers from the SPIVA Report:

Source:  S&P Dow Jones Indices, CRSP.  For periods ended June 30, 2013.  Outperformance is based upon equal weighted fund counts.  All index returns are total returns.  Charts are provided for illustrative purposes.  Past performance is not a guarantee of future results. 

The research firm DALBAR publishes the Quantitative Analysis of Investor Behavior report and every year it shows that individual investors are their own worst enemy. According to their research over the past 20 years the average investor in equity mutual funds has under performed the S&P 500 by an annualized 4.3% per year!  The S&P 500 returned an average of 7.81% for the period ending in 2011.  The average mutual fund investor posted returns of 3.49% per year!

These numbers certainly speak for themselves but what is even more alarming is that investors are paying higher fees for this underperformance.  According to Investopedia.com the average actively managed equity mutual fund charges an annual fee between 1.3% and 1.5%.  Let’s say the manager has a fund with $500 million – they would be charging fees of around $7 million!!  These managers are certainly not going hungry while delivering very lack luster returns to their shareholders!!  This leads us to ask…why do investors continue to invest their hard earned money into these mutual funds!?  Is it simply because that is what they have always done?  Perhaps they simply haven’t been educated on the better options that are available?

The Financial Industry and most Financial Professionals don’t talk about Index Funds.  Let’s face it…they are fairly boring as they follow the market and don’t have an exciting story or strategy behind them.  Guess what? Successful investing over a long period of time is actually supposed to be boring! If you want the excitement of playing games or want to risk your money against unfavorable odds…go to Las Vegas! On average index funds charge approximately .20% (that is at least 1% less than actively managed funds!).  They might not have the fancy names or expensive marketing behind them but they have the returns that warrant investors attention.

Many investors have given up on a ‘buy and hold’ strategy because they haven’t given it a fair chance, too short a time frame or attempted to do so with actively managed funds.  If an investor purchased Vanguard’s S&P 500 Index (VFINX) they would have had an annualized return of 10.6% since it’s inception in 1976.  This certainly doesn’t mean that these types of returns will be delivered every year but how many investors would welcome returns like that?

Here is the bottom line folks: If you are managing your own portfolio YOU are the CEO and boss and responsible for how it is performing. If you own mutual funds that can’t even beat a passively managed index over 80% of the time…you need to fire them! If you have a financial advisor who recommends mutual funds that are losing to these same indexes AND charging you his/her fee on top of that…YOU should fire all of them!

Does that sound too drastic or calloused? It’s just a smart business decision. If you’re serious about accomplishing your retirement or investment goals you need to run it like a business. Why waste money by paying more for under-performing choices? You’re not a non-profit charity and even if you were you wouldn’t donate your funds to a wealthy mutual fund. Wouldn’t you rather see more of your funds go to the cause you care about … in this case YOU?

If you own mutual funds and want to see how they stack against a customized portfolio using indexes as part of the core strategy…call or email us for a complimentary evaluation and proposal. We welcome your comments and feedback!