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The 6 Numbers Every Mutual Fund Investor Needs to See

By Alex Dumortier, CFA – Mar 17, 2016 at 11:11AM

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Over the long term, most mutual funds fail to deliver on their mandate to beat their benchmark index.

As markets adjust to the Federal Reserve's revised expectations for fewer rate hikes in 2016, the dollar is down, and global equities are making new highs for the year. U.S. equities, on the other hand, are little changed in late morning trading -- it appears the positive effect of the "Yellen put" is well balanced against the concerns reflected in the Fed's dovishness. The S&P 500 (^GSPC -0.04%) and the Dow Jones Industrial Average (^DJI -0.12%) (DJINDICES: $INDU) are up 0.27% and 0.42%, respectively, at 11 a.m. ET.

From daily market price action, let's pivot to a topic with broader importance for investors: the active vs. passive funds debate.

Last week, S&P Dow Jones Indices released their SPIVA U.S. Scorecard through 2015, and it does not make for pretty reading if you're a mutual fund manager -- or an investor in actively managed mutual funds. The numbers are absolutely awful; take the following table, for example:

Percentage of funds that failed to outperform their benchmark:


1 Year

3 Years

10 Years

All Large-Cap Funds

Benchmark: S&P 500




All Small-Cap Funds

Benchmark: S&P SmallCap 600




Source: S&P Dow Jones Indices.

That's right: Two-thirds of large-cap funds failed to beat the S&P 500 last year, and as you expand the measurement period to a decade, that figure rises to more than four-fifths! The corresponding numbers in the small-cap category are even worse.

Despite that dismal record, individuals continue to try to select mutual funds in order to try to accrue some "alpha," an incremental return over the benchmark return (I'm one of them -- I own actively managed mutual funds in my retirement account).

This is a product of what Vanguard Group founder and tireless index fund advocate Jack Bogle refers to as the "relentless rules of humble arithmetic":

Gross returns in the financial markets minus the costs of financial intermediation equal the net returns actually delivered to investors.

Your "take-home" return is the net return; i.e., the return that's left after all costs have been deducted, including the fees active managers charge.

Therefore, "[a]fter costs, we are losers to the market." Why? Because all funds, as a group, achieve the average market return, and there is no fund -- whether it be an index fund or an actively managed fund -- that doesn't charge a fee for its services (even if there were, there would still be transaction costs related to the purchase and sale of stocks, etc.).

That observation suggests an optimal strategy. Given that the odds of selecting a mutual fund that will beat the market over long periods are stacked against you (according to the table above, they're worse than four-to-one against in the large-cap category), the optimal behavior for a non-professional investor is to focus on the component in the "humble arithmetic" equation that's known at the outset: cost.

In other words, your objective ought to be to minimize your costs to achieve a return as close to the average return as possible -- which is exactly what index funds offer.

This is not a particularly original message, but it bears repeating. The good news is that it finally seems to be resonating with investors: According to data from Morningstar cited in the Financial Times, some $245 billion flowed out of active funds in the 12 months to the end of January, while $408 billion flowed into index funds.

Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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