The investment landscape is a tricky terrain with mirages that often lead to disappointment. Imagine you are an investor, and the oasis you seek is superior performance. Now, would you rather traverse this terrain yourself, picking your stocks, or hire a guide, an active fund manager? The answer might not be as straightforward as it seems.
According to extensive research, a staggering 94% of active fund managers do not beat the market. It's an inconvenient truth that even financial titans like Warren Buffett's Berkshire have now underperformed the S&P 500 over a 20-year period. But why is this so?
The Stock Picking Dilemma
Contrary to popular belief, the odds of picking a winning stock are far from a 50/50 gamble. Shockingly, 80% of all stocks have historically generated a 0% return. Yes, the remaining 20% of stocks are responsible for all the gains. If you pick a stock at random, your chance of making a profit drops to a lowly 20%.
Furthermore, the grim reality extends to large-cap stocks as well. A meager 26% of the stocks in the S&P 500 outperform the index returns, with only 5% generating multi-bagger returns. So, in essence, even if you have a nose for potential winners, the odds are stacked heavily against you.
Remember!! Every time you fail picking an investment in a project and you fill like sh*t: this is part of the game. Michael Jordan won 6 NBA rings. But he played 15 leagues. That means he lost 9. He only won 6/15!!
The Dominance of Tech and the Irony of Performance
The tech industry has indisputably dominated the last two decades. Still, a glance at the top ten performers in the S&P 500 from 2000 to 2020 reveals an intriguing fact. Only two of these frontrunners hailed from the tech industry.
Of course, we should consider Bitcoin and ETH in this study, but their perfomrance is out of this rank ;-)
Consider UnitedHealth, the second best-performing stock from 2000 to 2020 with a staggering ~5,000% return. Even with such solid fundamentals and impressive growth, it experienced annual drawdowns between -5% and -36%. Imagine holding such a volatile stock through these drawdowns, questioning your investment while the market soars.
Despite this amount of Drawdowns, take a look at this performance:
Does it sund familiar to you? Take a look into the downdraws of Bitcoin in this graph:
Similar scenarios unfolded with giants like Meta. Despite impressive financial metrics, the stock plummeted by 55% in 2022, only to rocket by 200% later. Such volatility tests the patience of fund managers, who often buckle under the pressure.
As this week's chart shows, however, almost no active fund manager consistently beat the benchmark, at least not over five-year periods. This is unexpected given that active fund managers can use their expertise and research to pick the winners and weed out the losers.
There is at least a half-dozen reasons why this is the case. The massive size of funds that are actively managed by the industry's behemoths – Vanguard, Fidelity, Schwab, Blackrock and so on – means they cannot beat the market because they are the market.
To examine the stock-picking record of active managers, I looked at the portfolio histories for all funds in the nine Morningstar Style Box categories dating to 2013 through the end of 2023. Over those 10 years, only 10% of mutual funds saw more than half of their stock picks beat the index.
In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons. Just one out of every four active funds topped the average of passive rivals over the 10-year period ended June 2023. But success rates vary across categories.
Last year, 47% of actively managed open-end mutual funds and exchange-traded funds beat their benchmarks - a marked increase over the 43% hurdle rate in 2022. Morningstar refers to the boost as a "surge." Yet active managers haven't become better at beating the market over the long term, as Morningstar acknowledges.
Less than 10% of active large-cap fund managers have outperformed the S&P 500 over the last 15 years. The biggest drag on investment returns is unavoidable, but you can minimize it if you're smart. Here's what to look for when choosing a simple investment that can beat the Wall Street pros.
It is relatively common to beat the market for 1–3 years at a time. That can largely be explained by luck. But the data clearly shows that even professional fund managers are unable to beat the market consistently over a longer period of time, like 10–15 years.
Another driver of the underperformance of active funds, according to McDermott, is fees: “All funds have years where they underperform, however, the longer-term evidence is undeniable that active managers have continued to struggle. The main reason for this underperformance is because active funds charge higher fees.”
On average, the Fidelity Contrafund has beaten the S&P 500 Index by 2.78% per year. Growth of $10,000 invested in Contrafund versus S&P 500 Index, September 17, 1990 to March 31, 2024. Total value March 31, 2024 for Contrafund was $751,828 compared to $327,447 for the S&P 500 Index.
Over a one-year period, nearly 60% of actively managed large-cap mutual funds underperformed the S&P 500 after accounting for fees. Over three-year and five-year periods, the percentages of underperforming active funds rose to 79% to 80%. Over 10 and 15 years, between 87% and 88% of active funds underperformed.
Investment fees are one major barrier to beating the market. If you take the popular advice to invest in an S&P 500 index fund rather than on individual stocks, your fund's performance should be identical to the performance of the S&P 500, for better or worse.
Actively managed investments charge larger fees to pay for the extensive research and analysis required to beat index returns. But although many managers succeed in this goal each year, few are able to beat the markets consistently, Wharton faculty members say.
Every year, some managers boast better numbers than the market indices. A small fraction even manages to do so over a longer period. Over the horizon of the last 20 years, less than 10% of U.S. actively managed funds have beaten the market.
He or she will help you construct a portfolio that gives you a good chance of reaching those goals, based on the best research available. But even the best financial advisors are at the whim of the market. Most professional investors who try to beat the market actually underperform it over a given time period.
Unfortunately not, by definition index funds can't beat the market. The reason being is because they invest exactly like the market, but are a product, created by a company, that has fees associated with it. So those fees will be the reason an index product can't “beat the market”.
For example, when the market is volatile or the economy is weakening, active managers may outperform more often than when it is not. Conversely, when specific securities within the market are moving in unison or equity valuations are more uniform, passive strategies may be the better way to go.
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Introduction: My name is Jerrold Considine, I am a combative, cheerful, encouraging, happy, enthusiastic, funny, kind person who loves writing and wants to share my knowledge and understanding with you.
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