The year 2006 has barely come to an end and the battle goes on. Which one has been the better investment? Index funds or actively managed mutual funds?
Standard and Poor’s reported that the S + P 500 index outperformed 69% of actively managed large-cap mutual funds in 2006. Additionally, the S + P SmallCap 600 outperformed almost 64% of actively managed small-cap mutual funds.
The story goes on to say that over the past five years, the S + P 500 index has beaten 71% of managed large-cap funds. The S + P SmallCap 600 has beaten 78% of managed small-cap funds in the same period.
I have no problem with these numbers, since in my advisor practice we use index funds/ETFs as well whenever they make sense in any given economic environment.
However, there is an ignorant part of that story that totally neglects to point out that markets don’t always go up. What will happen during a bear market?
A casual or inexperienced reader of the above figures could easily interpret them as an argument that index funds are the investment for all seasons. This is not the case. When a bear market strikes, such as the during the period of late 2000 to early 2003, index funds, as well as actively managed mutual funds, will go down sharply.
Some of them were pushed to such low levels that it took a Buy + Hold investor over 5 years just to get back to a break even point. What difference does it make that an index fund may be a better investment when you can lose just as much with it when the bear rears its ugly head?
If a bear market has the potential to devastate an investor’s portfolio, shouldn’t the primary emphasis of investing be to try to avoid that scenario, rather then some chest pounding over a couple of percentage points?
That’s my view, what’s yours?
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Comments 3
Ulli,
I believe your comments are right-on. As a newcomer to your free newsletter service — and having taken a few positions that you’re currently recommending — I think it’s great that you understand the fundamental idiocy of the “buy-and-hold” approach to investing.
One of the insanities of the above is that certain money managers get paid regardless of whether the fund makes money. This is morally and ethically wrong, in my opinion — not that they make a bunch of money (I’m all for that!), but that they should not be positively rewarded for basically helping other people lose money.
I would say anecdotally that most of the time they, themselves, either do not have their own monies invested in the marketed fund and/or they have themselves covered — probably literally — via other securities instruments!
Keep up the great work and may free enterprise flourish!
-Phil
Ulli,
I often think that this business of buying and holding for the long run, and focussing instead on a percentage here and there on this fund or that, is a way of deflecting our attention from the real problem.
The real problem is that during the last down turn (October 2000 to March 2003), a person that remained fully invested in the S&P500; index fund would have lost 50% of the value of their portfolio!!! Whether they were invested in fund A or B is immaterial, as the losses in any case would have been similar.
Wall Street hates us market-timers. When we pull money out of stock funds, there goes their expense ratio from which they get their profit!!!
Sanjoy
Sanjoy,
Absolutely. I couldn’t have said it better myself.
Ulli…