When talking about stocks, actively managed mutual funds claim they can beat the stock market. But is this true? Is it worth considering these options?
Actively managed mutual funds
These types of funds attempt to beat the market by picking winners and selling losers at the correct times. According to the latest semiannual Morning Start Active/Passive barometer report, actively managed funds are not only underperforming their index fund counterparts most of the time, but they are getting worse over time. Here is some info about these types of funds:
- On average, active mutual funds beat their index only 36% over the last year.
- In 2017, active managers beat the index 43% over that year.
- Worst yet, I’ve read numbers that only 1 in 20 active funds beat their S&P 500 index benchmark (like this article).
- Some mutual funds have front-end load and back-end load fees. These additional fees can take a massive bite out of your investments when you deposit or withdraw from these funds.
- Some actively managed funds outperform the index during bear markets but underperform during bull markets.
- It appears that actively managed funds don’t drop quite as much during long-term bear markets as index funds do.
But with that said, active fund performance varies greatly. If they were awful all the time, they probably wouldn’t exist. But choosing the right ones based on costs, fund managers, and past performance can be difficult. The higher the fees on the mutual fund, the harder it is for them to beat the index. Past performance is not a guarantee of future performance, but I would bet that this downward trend continues.
What is the average return for the full stock market?
Passively managed funds, also known as index funds, do not try to time the market. They either focus on stock indices or cover larger aspects of the full stock market. On average, the stock market has increased in value around 7% annually, which includes dividends and accounts for inflation. The stock market will fluctuate on any given year, so this average is over the long term. If you have at least ten years, you should be able to get close to that average. Below is a graph that shows the growth from 1928 (data gathered from here) to the end of 2018 for the S&P 500 index.
Looking at this chart, we can see there were two large bear markets in recent history (2001 and 2018). Each lasted around two years before the trend reversed. That is why the length of time in the market is important. It is dangerous to be heavily invested even in an index fund when you need to draw from it within a few years.
Regardless of whether you invest in active or passive funds, one crucial element to consider: when your investments start to tank, by dollar cost averaging, you can offset some losses when the stock market comes back up…even if it takes a while. In fact, in future posts, I want to talk about how you want a bear market when you start investing, as you end up purchasing stocks at discounts.
I am not confident that I can effectively choose active mutual funds that will outperform the market consistently, so my goal is to focus on passive investments through index funds over the long haul. Of course, that won’t happen until we wipe out our credit card debt. I’m not going to concern myself with timing the market, as it seems people who do this for a living have a hard time doing it consistently.
Do you invest in active mutual funds, index funds or individual stocks? How well has it worked for you?
Beating the market is a zero sum game.
Chris is a financial blogger who loves to be transparent about money-related issues. He’s paid off massive amounts of credit card debt and is the blog author of Money Stir. His main focus on Money Stir is talking about how money relates to our relationships, personal development, and how to plan for the future we want. He’s been quoted on Market Watch, The Ladders, and other publications.