Achieve Nearly Superior Results Among Professional Fund Managers: Acquire a Single Investment and Maintain It Indefinitely.
Ditch the high-priced financial gurus, mate. They might seem like the savvy ones, investing gazillions for their clients, but the reality's a tad different. They're supposedly smart, but the truth is, most of them can't even earn enough returns to cover their hefty fees. You don't need a fancy education or stock market secrets to outshine these pros over the long haul.
All you need is a simple S&P 500 index fund, like the Vanguard S&P 500 ETF (VOO -1.31%). Hold on tight, and it's a forever ticket.
Outsmarting the market ain't as easy as it appears
S&P Global publishes its SPIVA Scorecard biannually, shedding light on the number of actively managed mutual funds trumping their respective S&P benchmark index. It factors in stuff like survivorship bias, which, if unchecked, can inflate active fund performance. And guess what? Just over 8% of active large-cap U.S. equity stock funds surpassed the S&P 500 over the last 20 years.
Beating the market? Even for these fund manager vets? Piece of cake, right? Wrong.
First, consider this: The stock market, especially large-caps, is mainly ruled by institutional investors like active mutual funds' managers. About 80% of large-cap stock volume stems from these professional juggernauts. That means the price of a highly-traded stock depends mostly on these pros.
Translation? Active fund managers are fighting tooth and nail among themselves to find value and outdo the broader market. This battle between pros leads to any advantages they may have dwindling, leaving the odds of outperforming around a 50/50 shot.
Active management also falls victim to what Michael Mauboussin, author and head of Consilient Research at Counterpoint Global in New York, calls the paradox of skill. When skill is extremely high and consistent, luck plays a significant role in determining winners. Picture two equally skilled tennis players trying to win a point; a wild court bounce or a strong gust could decide the game.
But active managers don't just need to get lucky enough to outperform the market, they need to outperform by enough to justify their fee.
Jack Bogle and Warren Buffett school us on the impossible game of active management
In a 1997 speech, Jack Bogle, the big kahuna at Vanguard, spelled out a straightforward theory: "Investors as a group can't outperform the market, because they are the market," he declared. Oh, and he added this bombshell: investors, as a group, must underperform the market "because of the costs of participation." Those costs include transaction costs, administrative fees, and mutual fund expense ratios.
Warren Buffett addressed the same challenges for investors in his story about the Gotrock family. Once upon a time, the family owned every American corporation but squandered it all thanks to helpers like brokers, managers, and financial advisors. The moral of the story? If the Gotrocks had simply kept their ownership intact, they'd have seen far more wealth in the long run.
Minding your expenses is crucial to long-run investment success. Many actively managed mutual funds boast high expense ratios, particularly when compared to index funds. The Vanguard S&P 500 ETF sports a mere 0.03% expense ratio—it's tough to find anything cheaper.
Though there are fund managers who've outperformed fees for extended periods, pinpointing these champs is practically impossible beforehand. What's more, successful managers tend to attract attention (and the cash that comes with it). Their winning investments produce a hefty chunk of capital they must eventually deploy. With more capital to play with, the fund manager must stretch their portfolio to less promising investments, escalating the role of luck in outperformance. This often leads a smart and successful manager to become less successful (but no less bright) in the long run.
And there you have it—the untamed challenge that will never haunt an index fund, which simply mirrors the index it's engineered to trail. An index fund with a decent record of closely following its index's returns is a terrific investment for most individuals. With a low "cost of participation" and a humble expectation of matching the market, it can outperform the lion's share of actively managed mutual funds over the long haul.
- Despite the perceived expertise of high-priced financial gurus, an S&P 500 index fund like the Vanguard S&P 500 ETF can outperform them over the long term, making it a simple, long-term investment solution.
- According to S&P Global's SPIVA Scorecard, only a small percentage of actively managed large-cap U.S. equity stock funds have outperformed the S&P 500 over the past 20 years, indicating that outsmarting the market is not as easy as it seems.
- Michael Mauboussin, author and head of Consilient Research at Counterpoint Global, notes that active fund managers can struggle to outperform the market due to a paradox of skill, where even highly skilled managers face challenges from luck and competition among peers.
- Jack Bogle, the founder of Vanguard, believes that investors, as a group, cannot consistently outperform the market due to costs associated with participation, while Warren Buffett's parable of the Gotrock family demonstrates the importance of minimizing expenses in long-run investment success.
