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American Funds’ Investment Company of America vs. S&P 500 Index (Part 2)

By JLP | April 28, 2010

My post from yesterday raised some eyebrows and ruffled some feathers. I suppose I used a bit too much glamour when I used the word “smoked” in the title. I tend to do that sometimes when I want to draw attention to a post.

Some questions were raised about my methods:

Why did I choose a 10-year period? Well, I wanted to compare American Funds’ Investment Company of America with Vanguard’s S&P 500 Index Fund. My source for daily data is Yahoo! Quotes. Their data only went back to the mid-to-late 1990s. Since I was calculating the reinvestment of dividends on my own, I wanted to have daily data.

Did I “data mine?” No, I did not. I did not search for a mutual fund that would support my position (because I did not have a position). I would have posted the results REGARDLESS of the outcome. As I stated in my previous post, I chose American Funds’ ICA because I was familiar with them and knew that they had been around a very long time.

So…

Since I didn’t have daily data going further back than the mid-1990s, I decided to switch to annual data provided in the ICA’s Annual Report and data that I have for the S&P 500 Index*. Here is a year-by-year comparison (you can click on the graphic to see a bigger version):

Those figures do not include a sales load. They also do not include a management fee for the S&P. So, to get a little more accurate picture, I assumed a $1,000 investment in each and deducted the maximum up-front sales charge of 5.75% for ICA. Then, I calculated the returns for the last 5, 10, 20, 30, and 40 years. Here are the results:

Remember, these numbers DO NOT include any sort of management expense for the S&P Index, which favors the index. Another thing to note is that looking at the data, I’m sure there were rolling periods in which the index beat ICA.

These figures all go to hell if you look at dollar-cost averaging since each investment in ICA would take a haircut. It would be hard for ICA to overcome that obstacle. That’s why I would ONLY consider a load mutual fund if I was investing a lump sum.
*Although I refer to it as the S&P 500 Index, the index was composed of 90 stocks prior to 1957.

Topics: Index Funds, Investing, Mutual Funds | 35 Comments »


35 Responses to “American Funds’ Investment Company of America vs. S&P 500 Index (Part 2)”

  1. Paul Williams Says:
    April 28th, 2010 at 11:45 am

    This comparison only matters if ICA held only large cap U.S. stocks during every single period. As of right now, 11% is in foreign stocks and 2% is in bonds. I have a feeling this allocation has changed several times throughout the years.

    While the makeup of the S&P 500 has changed throughout the years, it has always been 100% U.S. Large Cap Stocks. This isn’t an apples to apples comparison.

  2. Paul Williams Says:
    April 28th, 2010 at 11:52 am

    Oh, I forgot to mention that ICA also has about 6% in cash. So as of right now, at least 19% of ICA’s portfolio has no resemblance to the S&P 500.

    ICA also has portfolio turnover of 20-30% in any given year, while VFINX averages a turnover rate around 10% or less. Taxes will result from the higher turnover and eat into returns if you’re not in a tax-advantaged account. It’d be interesting to see an after-tax comparison (though you’d have to do a bit of estimating).

  3. Kirk Kinder Says:
    April 28th, 2010 at 12:07 pm

    The American Funds are one of the good guys in fund management. The only beef I have is the same as yours: upfront commissions. However, the folks at the American Funds are not only good money managers, but they understand that in order to get brokers to use their funds that a hefty payment is required. Sad, but true.

    As far as the Investment Company of America, this is a long standing staple of the American Funds. However, comparing to the S&P 500 may be a bit misleading. Along with the items Paul Williams notes, ICA is a value fund. Value typically beats growth and blended funds over the longer term. I would like to see how this fund performed compared to an S&P 500 Value or Russell 1000 Value index fund. I think the outperformance would disappear.

  4. BG Says:
    April 28th, 2010 at 12:32 pm

    Sometimes Value beats Growth, and vice-versa.
    Sometimes Largecap beats Smallcap, and vice-versa.
    Sometimes Index beats Active, and vice-versa.

    This is a preference thing. Understand what you are buying (especially in regards to fees & taxes & asset allocation), and only _then_ pull the trigger.

    Just glancing at the table, 1990-1999 did not look good for ICA. The reason? who knows — maybe they switched managers, or some other factor. The issue with active funds, imho, is that you have no control over what the funds are buying, and you will not have any idea of what the funds did buy until way after the fact. 3-months ago, ICA was heavy-weight telecomms, who knows what they are now…

  5. Spokane Al Says:
    April 28th, 2010 at 1:09 pm

    You stated in part, “This figures all go to hell if you look at dollar-cost averaging since each investment in ICA would take a haircut. It would be hard for ICA to overcome that obstacle. That’s why I would ONLY consider a load mutual fund if I was investing a lump sum.”

    Perhaps I should run the numbers but intuitively I don’t understand your logic. If one invests $10k in a lump sum or $1k over a year, and faces the same front end loads, assuming the front end load, as a percentage of the investment remains the same, how is he/she any better investing in a lump sum?

    Unless perhaps you are referring to break points which generate declining front end loads?

  6. Luke (another one) Says:
    April 29th, 2010 at 9:50 am

    Great points Paul Williams….

    ICA is about 80% US equities and the rest is in cash, bonds and foreign. You can see how a financial advisor selling ICA to a prospect would use the S&P 500 index to compare and show how it out performs and to the unsuspecting client, he/she would buy it hook line and sinker.

    I really didn’t mean to pee in the proverbial pool on these threads, but I still don’t get the point of it all.

    GO back 30-years and you would have to pick this ICA fund out of 5,000 mutual funds (?) and stick with it 30-years, not add a nickel, have the money in a tax advantaged account, reinvest the dividends and THEN you would out perform the S&P 500 index! Exactly how many people did that? How many people selected funds that are now closed or miserably failed to match the S&P 500 index?

    Spokane Al…I think the DCA point was that there would be market ups and downs throughout the 10 purchase periods which would complicate the matter with prices fluctuating…

    Just for reference, the management fee for VFINX is 0.18%.

  7. JLP Says:
    April 29th, 2010 at 10:00 am

    Luke,

    I think you just made a case for active management.

  8. Luke (another one) Says:
    April 29th, 2010 at 10:48 am

    How?

  9. Retiredat40 Says:
    April 29th, 2010 at 11:21 am

    Luke,

    I think you are a little religious about index funds. Yes, it is difficult to beat an index but it is not impossible. And it is not unreasonable to expect a fund like ICA to outperform the index with an expense ratio of 0.6%.

    ICA uses an approach that has been proven to beat the market over time. If you were going to design a fund to beat the market, ICA would have all the bases covered. Not all mutual funds are created equal.

    One major weakness of an index is that it has to put a large portion of its funds into the biggest companies in the index. As a result, the largest companies get invested in more heavily than the smallest. In addition, an index fund is actually managed. It just does not have a lot of expenses.

    The S&P Committee consistently chooses high flying stocks to go into the index. That’s why they added Yahoo in the 1990s even though it had no earnings. Stocks removed from the index have a tendency to outperform the stocks added to the index. In addition, sectors that become overvalued become an increasing large part of an index.

    JLP gave props to ICA and it deserves some props.

  10. Luke (another one) Says:
    April 29th, 2010 at 12:18 pm

    Hindsight is a wonderful thing, isn’t it? Lets all co go back to 1980 and buy loads and loads of ICA. (No pun intended)

    I don’t think its impossible to beat an index, but you can’t suggest to me that ICA is the norm or even tracks the index we are discussing! Indexing has its drawbacks for sure, but over time it beats most active funds.

    Past performance doesn’t predict future performance so what is the overall point of it all? ICA will beat the S&P 500 going forward for another 75-years after loads and fees?

    There are 20,000+ mutual funds, of course there will be funds that beat their index, but over the long term, the number gets smaller and smaller and your ability to select these funds is based on nothing but pure luck! For all we know, ICA has runs its course.

  11. Retiredat40 Says:
    April 29th, 2010 at 12:50 pm

    True enough. But the reality is that everyone is not going to invest in an index. Most financial advisors can’t put their investors in an index. That’s just the way the game is played.

    And what are the odds that a person is just going to buy an index and hold it for 30, 40 or 50 years. There will be a small minority that do that but probably not many.

    If you can find a value fund with a low expense ratio and low turnover ratio, your chances of beating the index are greatly increased. The only trouble is to do that you have to find a fund that has been around for 50 years because no newer fund is going to have an expense ratio much less than 1.0%.

    ICA is one of the very few funds that would fit that category. I think we can agree that if a person is going to get put into a managed fund, ICA is about the best way to go. And they just might avoid the pitfalls of index investing by being overly invested in overvalued shares. They probably will not do much worse regardless.

    If I was ever going to invest in a mutual fund, give me a value fund with a very low expense ratio and I’ll take it over an index fund any day.

  12. Paul Williams Says:
    April 29th, 2010 at 1:01 pm

    Retiredat40:

    Why can’t financial advisors put their clients in index funds?

    Are you talking about a value fund beating a value index or the S&P 500?

    Why couldn’t you just invest in a value index fund with an extremely low expense ratio?

  13. Retiredat40 Says:
    April 29th, 2010 at 1:21 pm

    There are few major reasons financial advisors cannot put their clients in an index fund:
    1) They will starve to death
    2) They will get fired
    3) They aren’t available to them

    If they did put you in an index fund, it would likely be a high expense one that you’d probably be better off passing on.

    A value index would be fine. I was basically referring to a market index.

  14. Luke (another one) Says:
    April 29th, 2010 at 1:59 pm

    Retired…

    And vice-versa, what are the odds that a person will buy an active fund and stay in it for 30, 40 or 50-years? Lets be fair.

    Thinking outside the box, why can’t financial planners recommend index funds to their clients? I do and construct solid, low cost portfolios. Will I retire like Warren Buffet snagging uber premiums? No, but I sleep great at night. Take a look at DFA for their approach to index investing. It is index investing on the juice.

    So take an advisor managing client A’s portfolio. In addition to the 1.00% (lower or higher) annual charge for AUM and the 5.75% front end sales charge for getting into ICA and the 0.75% ER and 12B1 fees, how exactly can most active funds overcome this hurdle?

    As far as this is the way the game is played…I would concede if we were on some financial planning blog filled with advisors, but this is a consumer driven blog…Most (?) aren’t using advisors for their investing…They are coming here and to other blogs like this…to be sold active investing?

  15. Paul Williams Says:
    April 29th, 2010 at 2:21 pm

    That’s funny Retiredat40. I’m a financial advisor and I recommend my clients use Vanguard’s index funds. But maybe it’s because I don’t charge commissions. There are other ways for advisors to make money. Hourly fees, flat fees, and % of assets under management are alternatives that would easily allow advisors to put clients in index funds.

    If you were referring to a market index, then why would you say “give me a value fund with a very low expense ratio and I’ll take it over an index fund any day”? A value fund has nothing to do with a market index. What you’re saying is that you prefer value investing. I do too, which is why I advise clients to tilt their portfolios toward value. Value investing and index funds are not mutually exclusive.

    Just because you’re using index funds doesn’t mean you’re only investing in the S&P 500.

  16. Retiredat40 Says:
    April 29th, 2010 at 2:40 pm

    Luke and Paul, you know very well that most financial advisors can’t put their customers in index funds and keep their jobs or make a living.

    Yes, some do. That’s why I said “most.” I’m glad you are both able to do that. Let’s try not to get too defensive.

    As for the post, I thought it was a rather good one and I found it quite interesting. I never would have guessed that ICA had outperformed the market over every 10 year time frame and for 76 years as well. That’s the kind of thing I like to read about on a blog.

    It’s not like JLP never writes abouts the advantages of index investing. We’ve all heard that a thousand times. Beats a political post.

    As for a value fund having anything to do with an market index, it has everything to do with a market index. The reason you invest in value is to decrease risk and outperform the market. The only way to know if you are successful is to compare the results to a market index.

  17. Kirk Kinder Says:
    April 29th, 2010 at 3:26 pm

    People should never work with a planner who can’t use index funds. If a planner is stuck with a small set of options, then the client is going to get screwed. I am not saying all advisors should use them, but clients shouldn’t work with a planner who is limited in where they can go.

  18. Spokane Al Says:
    April 29th, 2010 at 9:47 pm

    The discussion concerning planners and advisors using index funds is a good one.

    It amplifies the difference between a true financial planner who is affiliated with a Registered Investment Advisor and has a fiduciary responsibility towards his/her clients and that of a registered representative. The registered rep is affiliated with a broker dealer and must only meet a much lower standard of client suitability in order to pitch a product.

    Also, as Paul Williams stated, a true financial planner has a number of ways in which to be compensated, while the registered rep has only one source of income – he/she must sell you something. He/she earns nothing for advice.

  19. JLP Says:
    April 29th, 2010 at 11:46 pm

    Retired (#16):

    That was a very nice comment. Thank you very much. I know we do not agree on politics so I’ll always treasure that comment…lol.

  20. JLP Says:
    April 29th, 2010 at 11:53 pm

    Regarding this not being an apples-to-apples comparison…

    I don’t think there’s any way to make this an apples-to-apples comparison. The S&P 500 Index seems to be the gold standard in benchmarks. I understand why you wouldn’t want to compare a small cap fund with the S&P 500 Index but I don’t think it’s out of line to compare ICA with the S&P 500 (especially since Morningstar does too).

    What are we supposed to do? Look for an index until ICA can’t beat it and then call that fair? Wouldn’t that be “data mining?”

    For the most part, I am a believer in indexing. I think it’s a sound strategy. I just found the it interesting that American Funds (a load fund family) had a fund that beat the index.

    One last thing. For those of you who like John Bogle, keep in mind that he has a vested interest in promoting index funds. He’s not doing this solely out of the goodness of his heart (though I do think very highly of Mr. Bogle).

  21. Paul Williams Says:
    April 30th, 2010 at 9:51 am

    Retiredat40:

    I understand about “most” financial planners. I didn’t mean to get defensive. I just wanted to point out that it is possible for financial planners to use index funds. Registered reps could switch to RIA. But I’ve found that most who do that don’t use index funds because they’ve only ever known active funds.

    I also understand what you’re saying about comparing the performance of a value fund to a market index. But when we’re talking about investing, you could invest in a value index fund. Then the advantage becomes quite a bit smaller.

    JLP:

    I’m not saying we should cherry-pick an index until we find one that beats whatever fund we want to look at. But I think the problem comes when a fund says they’re “large-cap growth” but they invest differently. Then we compare them to the S&P 500 and WOW they beat it! I would almost always expect a diversified portfolio (with int’l and small stocks) to beat the S&P 500.

    And I don’t worship at the altar of John Bogle. :) He makes many good points, but too many people rely solely on him for index fund advice.

  22. Luke (another one) Says:
    April 30th, 2010 at 11:15 am

    JLP…

    ICA has a great track record…What next? What do you want a reader take away from these two posts? Is it as simple as there is a active fund that can beat the index it tracks?

    Is anyone really surprised that out of THOUSANDS of mutual funds, one beat the index? It’s not the norm. Its EASY to say after the fact that ICA is great and beat the S&P 500 index..

    The real radical strategy is picking the next mutual fund out of 20,000 that will outpace their index for 30-years or more and doing so today, APril 30, 2010 and sticking with it.

    The perfect example is Bill Miller who runs the Legg Mason Value trust beating the S&P 500 index for 15-years in a row, and then giving back most if not ALL of the gains in the following 3-years. MOST of the people didn’t begin 18-years ago with Bill Miller, the money started to pour in lets say after 10-years and he began to make a name for himself. THOSE people are even screwed MORE because they missed 10-years of growth.

  23. Retiredat40 Says:
    April 30th, 2010 at 11:48 am

    Luke,

    Is JLP restricted from writing about any managed funds on his financial web site? You are being a little ridiculous.

    He called the attention to ICA for its past performance. He didn’t recommend it as an investment.

    @JLP Who knew it was possible?!!!

  24. Retiredat40 Says:
    April 30th, 2010 at 12:13 pm

    For all the love going to financial planners/RIAs here, I think it should be noted that just because an advisor puts a client in an index fund does not mean they are going to outperform ICA.

    An advisor needs a stream of income one way or another. If an advisor puts them into a assets under management fee-based portfolio, they are probably going to underperform the person who just went to Edward Jones and paid the load for ICA.

    If an advisor is going to charge hourly or flat fee planning or advisement, they are going to have to be one heck of a salesman to keep the people coming through the doors and paying the fees needed to keep the business going.

    I would become an RIA tomorrow and start my own business if I thought for a minute I could make a living selling index funds. All I have to do is submit the paperwork. I’m not enough to a salesman to pull that off.

  25. Paul Williams Says:
    April 30th, 2010 at 12:19 pm

    Retiredat40:

    Even better would be to skip the adviser or broker and do it yourself.

    I don’t support AUM models because I don’t think they’re right for clients. You end up paying based on how rich you are – not how much value you’re getting from the planner (or time spent helping you).

    There’s more to financial planning than investing. That’s the fun part, so everyone focuses on it. I agree it would be difficult to have an hourly or flat fee business where you only “sell” index funds. Luckily, there’s a lot more to “sell” than just investments.

  26. Luke (another one) Says:
    April 30th, 2010 at 2:26 pm

    Whats the POINT HERE?

    No $hit there are a few active funds here and there that can beat an index….

    WHAT AM I SUPPOSED TO PULL FROM THIS INFORMATION?

  27. Spokane Al Says:
    April 30th, 2010 at 10:31 pm

    Retiredat40,

    There is a great deal more to being a true financial planner than offering index funds/investment advice. Take a look at the robust CFP course of study, complete that, sit for the two day exam, and then offer people comprehensive financial planning and you may do just fine.

    If you just offer investment advise via index funds or assets under management you have changed your hat from a rep to an investment advisor rep, but have done nothing to change your skill set nor your mind set.

  28. Travis Says:
    May 3rd, 2010 at 7:58 am

    Good write JLP. Plenty of active managers have killed their benchmarks for long periods of time.

    Investment Company of America isn’t my favorite US Large Cap Blend fund, but it does have a decent track record.

    My current numbers show an average annual outperformance of 3.11% over the past 10 years (no up-front load). Take .75% off for financial planner’s fee and refund the 12b-1 fees back to client, and the client still comes out way ahead here.

    Keep in mind, you should really compare funds to the SPY or some kind of actual ETF investment. No one can invest in the S&P 500 directly.

  29. Luke (another one) Says:
    May 3rd, 2010 at 1:32 pm

    Please define “long term” and “plenty” in some sort of quantatative way. Studies show the longer you hold an active fund, the more likely it is to underperform its tracking index.

    And please define “killed”.

  30. JLP Says:
    May 3rd, 2010 at 1:41 pm

    Travis wrote:

    “Take .75% off for financial planner’s fee and refund the 12b-1 fees back to client…”

    So you’re saying that a planner would make 50 basis points on this particular account?

  31. Spokane Al Says:
    May 4th, 2010 at 1:49 pm

    Travis wrote: “Take .75% off for financial planner’s fee and refund the 12b-1 fees back to client…”

    I wonder if FINRA would allow a registered rep to refund any fees from his/her pocket directly back to the client.

    I suspect not.

  32. BG Says:
    May 7th, 2010 at 12:29 am

    **rant on**

    Back to my comment on #4, in light of the fiasco in todays market. Some fund, somewhere, was selling CenterPoint Engergy (CNP) for $0.00 a share! Literally giving the stuff away for free.

    The same fund, likely, was selling their stake (your stake?) of Accenture (ACN) for $0.01 a share. That stock was selling for $40, then selling for a penny, then back to $40 in less than 10 minutes.

    One or more funds literally were giving away their holdings in these companies, and likely others (just search for stocks with a 1 day trading range between 5 cents and $40). Whether it was a ‘computer error’, or just retarded programming, it makes no difference really — these actively managed funds are playing games with your hard-earned money.

    I predict the culprit company will not be ratted out, but I have pretty good faith that it wasn’t some index fund that was dumping their portfolio for $0.01 a share. I am amazed that the NASDAQ and NYSE are invalidating those trades after the fact, but you can bet that the little guys who had their shares stolen on margin calls aren’t getting a mulligan from the brokerages.

    I will forever stick with index funds, that way I know what I’m buying and at what price — and I especially know what I’m selling my stuff for, when it comes time for _me_ to decide when to do so. Not a crappy computer model buying and selling 5 million times a second like it is WOPR in WarGames.

    **rant off**

  33. Bender Says:
    May 8th, 2010 at 8:30 am

    Did I “data mine?” No, I did not.

    RIGHT, instead of randomly picking an actively managed fund you pick a fund you were “familiar” with, but it wasn’t a data mine. Sure.

    BTW – On a total return basis versus the S&P 500, AVISX is +2.82 over ten years, +.56 over 5 years, +.69 over three and -3.90 over the last year. The point is if you weren’t in this during the initial periods you missed the performance.

    Show me one credible statistical analysis that shows past performance has any significant positive correlation to future performance and then we can talk.

    But you sure didn’t data mine. . .

    @Travis lol you have a funny definition of “plenty”

  34. Mike Says:
    February 12th, 2014 at 3:52 pm

    The morningstar chart does not agree re: the superiority of ICA. For the past 10 years the ICA “A” shares show a gain of 91.1% vs the S&P 500 gain of 93.1%. Close but no cigar. I don’t know how the front-end load is figured. The ICA “C” shares show a gain of 76.1%, which seems about what 1%/year compounded would add up to.

  35. JLP Says:
    February 13th, 2014 at 12:56 pm

    Yes. This post is four years old. Things can change. At the time of the post, I had the numbers correct.

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