As we rumble along with what is now the longest bull market in history, it’s worthwhile to look back and ask: Could you have done better by doing something different?
The clear answer from Morningstar is “almost certainly not.”
The investment research firm produces a report every six months it calls the “Active/Passive Barometer.”
The report is meant to answer a basic question, whether investors should use expensive actively managed funds or simply own low-cost index funds that track the stock market.
The verdict: More than ever, just own index funds.
The newest edition of the barometer report holds that just 36% of active managers beat their indexing peers.
That means you had a one-in-three chance of picking a manager who could give you a return better than a broad index fund of the same investment type, after subtracting their fees.
Put another way, roughly two out of three managers would have lost you money compared with owning an index fund.
That figure was 43% last year, so things are getting worse, not better. Of the 19 fund categories tracked by Morningstar, 15 lost ground in this updated review.
If you looked from June to June, the time frame of the current study, it’s obvious the stock market went up.
In between, naturally, there were some gut-wrenching declines, particularly in February and March — and more recently.
An optimist would look at that volatility and conclude that a prescient trader would have cleaned up, buying low and then holding through the rises in stock values that followed. It has been, as some investment pundits put it, “a stock picker’s market.”
A pessimist, of course, would have bailed out at the first sign of trouble.
And a realist would have done what the index-fund investor did by default — ignore the month-to-month movement of the stock market — and come out well ahead of the pack of supposed professionals.
At least one category, intermediate bond managers, had better luck. More than 70% of them beat their indexes net of fees.
Morningstar chalks this up to taking on credit risk at the right time, so “luck” is probably the right term here.
The investment committee at my firm, which includes Princeton Professor Burton Malkiel, author of “A Random Walk Down Wall Street”, has studied bond alternatives closely for our own clients.
Finding reliable income without increased risk has been as much art as science over the past few years. At the portfolio level, this kind of thoughtful work is worthwhile.
Nevertheless, Morningstar blames weakness in the majority of other investment categories on the very fact that active managers trade rather than simply buy and hold.
“Stylistic headwinds and tailwinds explain some of the fluctuations in active-fund success. Also, active managers tend to have difficulty keeping up with index funds in strong markets, as many will keep cash on hand to make opportunistic investments or meet redemptions,” they wrote.
“The resulting cash drag can weigh on their performance.”
An expensive hobby
As time wears on the picture gets no prettier.
“Most active managers’ long-term track records leave much to be desired,” the authors concluded.
“In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons.”
Putting it that way raises an important question: What other time horizon is there over which to invest?
If you put cash into stocks and bonds in hopes of a short-term “win,” frankly, that’s not investing. It’s trading.
Trading stocks is an OK hobby, but it’s an expensive one. Every dollar you lose today fails to compound for your future, forever.
The cost of trading is not short term. It’s always long term — unless you’ve found a way to accurately identify stocks with their biggest appreciation still ahead of them.
If you have, well, you’re beating Wall Street soundly at its own game, one that a strong majority of professional investors on Wall Street does not win over time.
Some managers can, sometimes. Most don’t. In fact, your real chance to beat Wall Street lies squarely in not playing their costly, conflict-filled game in the first place.