A very small minority of managed mutual funds have topped the S&P 500 over any significant amount of time. A small minority of funds even survive for decades, let alone beat the stock market's average return. Even during the great bull market of the 1990s, only a small minority of funds topped the S&P 500, and those that claim they did are doing so before taxes are considered. After taxes, they very well might not have.
Vanguard's John Bogle shows evidence that the statistical probabilities of an active mutual fund manager beating the pre-tax return of the S&P 500 index are: One year, 37%; 10 years, 15%; 25 years, 5%; 50 years, 1%. In other words, the odds of mutual funds beating the index over time are very low.
Although it's impossible to cite numbers in this case, it is also safe to conclude that only a small minority of individual investors beat the S&P 500 index. Most lose to it. In limited studies done in the past, most individuals lose to the index at least as badly as managed mutual funds do. They trade too often. They pay too much in commissions and taxes. They try to time stocks and fail miserably, buying high and selling low.
If you can't beat the S&P 500, simply buy the index. Save yourself the study, work, and occasional heartache and worry. Simply buy the index fund and call your investing life a success -- because over the long run, it should be. It should be more successful than most pros are over their entire lives, and those pros study investing continually, always attempting to do better than the average, but usually failing.
There is another thing that an index fund protects you from: Change. It saves you from the continual change that happens in business and industry. Index fund boards weed out dying companies and replace them, automatically, while you're off fishing a cool stream, traveling to new places in the world, or, most likely, at your workplace, but unworried about your investments.
Our companies are changing
In Drip Port, we buy individual stocks on the grounds that we enjoy this stuff and we believe that we can indeed top the index fund. We'll continue to study and invest in individual companies as long as we continue to enjoy it and as long as we do well by it (so far, we're up 6.5% annualized versus 1.8% for the S&P 500). But if I start to dislike this type of investing, or I continually do poorly, it's off to an index fund for me; end of story. Because why bother with something that you're not enjoying or doing well when there's a great solution available?
As long as we're buying individual companies, though, we must keep current with them, continue to learn about them, and, unfortunately, frequently experience unexpected changes with them. In our short four-year life, consider what we've already had to learn about and accept:
- Pepsi (NYSE: PEP) moved to buy Quaker Oats (NYSE: OAT) soon after we started buying Pepsi. Surprise! Luckily we're okay with the idea -- a tribute to buying good management when you buy stocks, so that you agree with their decisions. The Federal Trade Commission (FTC) approved the deal yesterday.
- Johnson & Johnson (NYSE: JNJ) spent billions to buy a few biotech companies we had to study.
- Intel (Nasdaq: INTC) has spent billions buying networking companies. We didn't really care to invest in the networking biz, but here we are.
- In a change unrelated to business, but relevant to us, Campbell Soup (NYSE: CPB) added high fees to its Drip plan. Surprise again.
Now we face more changes with our companies. Namely:
- Mellon Financial (NYSE: MEL) is exiting the retail banking business (not a giant surprise) and is cutting its dividend by a big 50% partly in order to reflect that it is a financial services company. These companies traditionally pay lower dividends than banks do.
- Campbell Soup is cutting its dividend 30% to increase funds for capital investment and bring its yield closer to the average food stock as Campbell launches a new business plan. It is concurrently lowering earnings estimates by 20% for 2002 and restating its long-term earnings growth goal, which was 12% to 15%, down to 8%.
Not that I would change what we're doing, but if we owned an index fund instead of five stocks, we wouldn't need to consider any of this stuff. That said, we wouldn't be having nearly as much fun, either, would we?... Would we? And our return would be almost flat after four years.
What these changes mean to us
I understand why Mellon is lowering its dividend. The company is focused almost solely on financial services now, or soon will be, and dividends in that industry are lower. The money, about $225 million annually in its case, will be reinvested in the business instead. That's great as long as management is able to consistently earn a better return on the money for shareholders than we could have earned ourselves by, first, being paid it, and second, putting it back in the stock.
But I'm still somewhat bummed by the lower dividend. Mellon was our highest-yielding stock. I even viewed it as our one fairly high-yield investment (even at a slight 2.5%, I know). We've long talked about finding a high-yielding stock to round out our portfolio, and this change may push us closer to doing that. The only question: Once we find a high-yielder, will its dividend continue for years? We can't know.
Campbell's dividend change is minor to us; our dividends from the company are menial anyway. These changes and the new projections do push us a step closer out the door, however. We don't care to own an 8% grower. That's lower than the S&P 500's average annual return since 1926, which is 10.6%. I wrote a bit about Campbell on the Drip discussion board. We've said it before, but it's more true now than ever: Campbell's eventually on the way out of the Drip Port.
And a good change!
If we're lucky and we've chosen well, most changes that our companies make will be for the better. One change that is very much for the better: Paychex (Nasdaq: PAYX), which a month ago announced new high fees in its Drip plan, has nixed that change entirely. Paychex has returned to a fee-friendly plan largely thanks to all the letters that it received from investors, including Fool readers. Management listened. This means that Paychex returns as the favorite in our high-growth study. We hope to make our new buy decision this month.
In summary, change is constant, as we all know, both in life and in investing. If you buy individual stocks, you must be willing to follow company changes and adjust or change your positions. When you buy an index fund, you needn't have such concerns. Both ways of investing have advantages and disadvantages, and only you eventually know what is best for you. We're here to help you learn.