It strikes me that it’s very hard to consistently beat the market indices. After management costs are paid it becomes even harder since index funds have such low costs.
While some managed funds do beat the market for a while my impression is that studies have shown that the indices win in the long term, and investments should be about the long term.
It also seems to me that that there really isn’t any reliable way to pick the market beating funds from among the thousands of possible funds. If I can’t be sure of picking a good fund, why not pick the cheap average fund? If 70% of funds do underperform then my chance of picking a worse fund is at least 70%- likely much higher after fees.
How would you justify picking an actively mutual fund X to a client? I can see following winning managers or past performance but neither seems to be a real guarantee. In fact it seems both would lead to buying funds at a premium.

-Rick Francis

thanks

Vanguard Portfolio (5 yr numbers):
beta = 1.05
std dev = 9.90
average annualized return = 14.73%

Acitively Managed Portfolio (5 yr numbers):
beta = .73
std dev = 7.65
average annualized return = 18.62%

So let’s see: by going with the mutual funds with higher fees, not only do you got an average yearly outperformance of 3.89%… but you do it with 30% less risk (beta)! And yet, 90% of the readers here sound like they would take the 1st option simply becuase of lower fees!

Sure, past performance does not guarantee future results, but if you find the right managers who have consistently added risk-adjusted performance throughout the years, there is a good chance this will continue.

You are correct. I did focus on fees.

Just because a fund has outperformed an index in the past does not necessarily mean it will continue to outperform in the future. Yes, some funds do, but that wasn’t the point of my post.

You said:

“For about 8 out of 10 clients, the average up and downs of the S&P 500 are much too wild for the client’s needs/tolerances, let alone a mix of U.S indices and international indices!”

Really? Do you work mostly with retirees?

First thing we do is determine risk tolerance. For about 8 out of 10 clients, the average up and downs of the S&P 500 are much too wild for the client’s needs/tolerances, let alone a mix of U.S indicies and international indicies!

We then build a diversified portfolio and compare it against either the S&P 500 or a customized benchmark. That way, the clients knows exactly how much risk they are taking on and roughly what kind of performance one can expect. It’s through this process, the clients can really see the value-added of hiring the best money managers in the world to run their money. The best is when we can show a client a proposed portfolio with low correlation, less risk than the market, matches their risk tolerances, and still has a good chance at “beating the market.”

Just curious…Once you determine the appropriate risk tolerance for the client, isn’t the best thing then to set the proper asset allocation to match that risk tolerance? Then your benchmark for evaluation becomes the relevant hypothetical “index” for that particular asset allocation?

Take a look at the recommended Davis New York Venture fund, for example. The fund outperformed the Vanguard Total Market index by an average annualized return of 1.57% over the last 5 years, 2.27% over the last 10 years, and 1.87% over the last 15 years. When you also take into consideration that this fund only has a beta of .86 (14% less risky than the S&P 500), I think the client is still in a far better situation if he/she goes with the advisor. Not only is he exposing himself to less risk, but he is outperforming the S&P 500. By judging a fund, or a total portfolio for that matter, only by the fees is foolish.

Now, look at First Eagle Global’s numbers. The fund outperformed the Vanguard Total Market index by an average annualized return of 7.77% over the last 5 years, 9.77% over the last 10 years, and 4.13% over the last 15 years! Are you still going to complain about the fees with those numbers??

If you can find an advisor who filters for only the BEST risk-adjusted funds at a reasonable cost, most times the client would be far better off going with an advisor than if they simply socked the money away in the lowest-cost funds they can find.

And no, I do not think 12 funds is excessive in a well-diversified portfolio (over $150-2000k) if they are properly selected from different categories (lg caps, small caps, international, emerging markets, inflation adjusted bonds, hi yield bonds, alternatives, etc). Lowering your correlation to the markets is invaluable, as is lowering your overall portfolio risk levels.

Also, all clients do not have the same risk tolerances, so why should portfolios? Funds allow the advisor to better cater this risk by diversifying the risk or buying funds with lower risk levels.

Yes, 70% of all mutual funds “underperform.” But a fund that returns 9% (when the market returns 11%) with 50% less risk than the market is not a bad fund like those commercials make it seem! So really, we are talking about 40-60% of mutual funds being very much worthwhile for clients – all things considered.

I hope you give these other considerations more attention going forward. Thanks!

Take me. I’m bright enough to learn about my computer and handle all of the software and hardware issues that come up for my business — if I want to invest the time and energy to learn. But I don’t want to. Plus I find computers boring. I’d much rather pay my “computer guy” to keep up with all that stuff while I do more fun things with my business and life. Lots of people take that exact same approach with their finances and investments.

@Dave…You make my point exactly. It seems logical to you or me (personal finance junkies hanging around blogs on a Sunday) that someone would want to spend the time learning for that kind of money. In hindsight it’s a no-brainer. The general population, however, is virtually clueless about investment fee structures and the real costs. In addition, most people lack the skills or knowledge to decipher those investment fee structures in order to do the math to determine the real cost of a particular portfolio over time.

C shares are load shares. Why? Because if they were truly no-load shares, they would not have increased management expenses to make up for the difference. I realize that advisors need to get paid for their services, but let’s be realistic: C shares ARE load funds.