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Home>Daily Capital>Investing & Markets>Guaranteed Failure With Mutual Funds

Guaranteed Failure With Mutual Funds

Sixty Eight percent of US Large Cap Funds lagged the S&P 500 benchmark over the previous five year period, according to the mid-year 2012 Standard & Poors Indexes vs. Active Funds (SPIVA) Scorecard. This result is consistent with historical patterns and results for other market segments.

A 68% chance of underperforming means a 32% chance of outperforming. These are tough odds, but the entrepreneurial nature of many Americans encourages them to believe they can find a way to beat them. Unfortunately, the odds get even longer with a portfolio of funds.

Let’s assume that funds which outperform do so by an equal magnitude as the amount of underperformance by those lag. Historically, this is a very generous assumption.

If you own six funds, your chance of outperformance drops below 15%. With twenty funds, the odds fall well under 10%. Ok, we admit this is still too high to guarantee failure, but there is no rational reason anyone would want their money facing a headwind like this.

One of the biggest fallacies in investing is having confidence in a mutual fund manager because of a strong track record. Of the thousands of active managers, statistically, some of them simply have to outperform. This has nearly nothing to do with what will happen in the future. In fact, the opposite may be the case.

According to the December 2012 SPIVA “Persistence Study”:

  • Very few funds manage to consistently stay at the top. Of the 707 funds that were in the top quartile as of September 2010, only 10% were still in the top quartile at the end of September 2012.
  • Looking at longer-term performance, only 5.16% of large-cap funds, 3.21% of mid-cap funds and 5.10% of small-cap funds maintained a top-half performance over five consecutive 12-month periods. Random expectations would suggest a repeat rate of 6.25%.

You don’t hear much about the headwinds of mutual fund investing because financial companies are making a lot of money selling actively managed mutual funds. But the numbers don’t lie. If you own a bunch of mutual funds, we encourage you to reevaluate your strategy.

The content contained in this blog post is intended for general informational purposes only and is not meant to constitute legal, tax, accounting or investment advice. You should consult a qualified legal or tax professional regarding your specific situation. Keep in mind that investing involves risk. The value of your investment will fluctuate over time and you may gain or lose money.

Any reference to the advisory services refers to Personal Capital Advisors Corporation, a subsidiary of Personal Capital. Personal Capital Advisors Corporation is an investment adviser registered with the Securities and Exchange Commission (SEC). Registration does not imply a certain level of skill or training nor does it imply endorsement by the SEC.

Craig Birk leads the Personal Capital Advisors Investment Committee and serves as Chief Investment Officer. His focus is translating improvements in technology into better financial lives. Craig has been widely quoted in the Wall Street Journal, Bloomberg, CNN Money, the Washington Post and elsewhere. Prior to Personal Capital Advisors, he was a leader within the portfolio management team at Fisher Investments, helping assets under management grow from $1.5 billion to over $40 billion. Craig graduated from the University of California at San Diego and has earned the Certified Financial Planner® designation.
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