We love smart people who are generous with their knowledge. Warren Buffett, for example, not only heads the amazingly successful firm of Berkshire Hathaway
Another financial giant is John Bogle, founder and former chair of the Vanguard Group and father of the index fund (which we have long recommended for most investors). He often speaks out about the state of mutual funds today and has written books about the topic as well. (Check out Common Sense on Mutual Funds.) In a recent article for the Financial Analysts Journal, Bogle shared some thoughts on how the mutual fund industry has changed over the past 60 years.
Bogle started by saying, "The mutual fund industry has undergone tremendous change in the past 60 years. Total assets, number of funds, and fund costs have increased exponentially, while both the duration of the funds' portfolio holdings and the duration of their shareholders' holdings have tumbled. The industry's ownership of corporate stocks is at an all-time high, yet mutual fund managers have been noticeably absent from the corporate governance debate." He then noted that the changes he's seen since 1945 have mostly rewarded fund managers, while hurting investors.
Here are a few specific eye-opening statistics he shared:
- Fund assets in 1945 totaled less than $1 billion, whereas they total more than $7 trillion today. That's an increase of more than 7,000-fold. There were just 68 or so funds 60 years ago, compared with more than 8,000 today. That's roughly the equivalent of one fund per stock that exists.
- The fund universe in 1945 was mostly just stock-based funds, whereas today those account for 57% of funds. Today, 17% of funds focus on bonds, and 26% are money market funds.
- Today, almost 40% of assets in funds are held in retirement accounts such as 401(k) plans and annuities. (What?! You're not sufficiently invested for your retirement? That's not good at all, but we can help you remedy the situation. Grab a free trial of our Rule Your Retirement newsletter, and let us guide you.)
- Whereas funds of yesteryear focused mostly on blue-chip U.S. companies, only about 14% of stock funds today do so. Today, you'll find lots of funds focused on small companies, geographical regions (such as Latin America or Russia), and industry niches (such as real estate or health care).
- "Sixty years ago, an investor could have thrown a dart at a broad listing of stock funds and had three chances out of four of picking a fund whose return was apt to closely parallel that of the U.S. stock market. Today, that investor has just one chance out of seven." This is a good argument for sticking with index funds, unless you're prepared to carefully seek out exceptional funds.
- While funds in 1945 were mostly managed by committees, today we have a star system. Some managers turn out to be short-lived "comets," while others are legitimate stars, such as Peter Lynch, who ran Fidelity's Magellan Fund
(FUND:FMAGX), and Bill Miller of Legg Mason Value Trust (FUND:LMVTX).
- Speculation has become rampant. Managers of yore would hold onto stocks for years, while these days it's often months. "Indeed, between 1945 and 1965, annual portfolio turnover averaged a steady 17%, suggesting that the average fund held its average stock for about six years.... Fund managers now turn their portfolios over at an average rate of 110% annually."
- Funds in 1945 owned a little more than 1% of all American public companies. Today, that figure is almost 25%. Bogle opines, "With their long record of passivity and lassitude about corporate governance issues, fund managers must accept a large share of the responsibility for the ethical failures in corporate governance and accounting oversight that were among the major forces creating the recent stock market bubble and the bear market that followed."
- In 1945, shareholders tended to hold on for a long time -- typically around 16 years. Today, a typical holding period is more like three or four years.
- Fund costs, meanwhile, have increased. The average expense ratio for the largest funds in 1945 was 0.76%, and it's now 1.56%. Bogle notes: "In other words, while their assets were rising 3,600-fold, costs were rising 6,600-fold. (The dollar amount of direct fund expenses borne by shareholders of all equity funds has risen from an estimated $5 million annually in the 1940s to something like $35 billion in 2004, or 7,000-fold.) Despite the substantial economies of scale that exist in mutual fund management, fund investors have not only not shared in these economies -- they have actually incurred higher costs of ownership."
- Between 1983 and 2003, the stock market's average annual return was 13%, while the average stock mutual fund's return was just 10.3%.
So what should we do?
The world of mutual funds has clearly changed a lot in the past six decades -- and in most respects, not for the better. So what's a Fool to do? Well, I've got some suggestions.
Be above average by being average. In other words, forgo managed mutual funds and stick with simple index funds, which track indexes such as the S&P 500 or the total stock market. Their fees tend to be considerably lower, and they have, for many decades, outperformed the majority of managed equity funds.
Even superinvestor Warren Buffett sings the praises of index funds for most investors. In his most recent letter to shareholders, he noted: "Over the (past) 35 years, American business has delivered terrific results. It should therefore have been easy for investors to earn juicy returns: All they had to do was piggyback Corporate America in a diversified, low-expense way. An index fund that they never touched would have done the job. Instead many investors have had experiences ranging from mediocre to disastrous."
Of course, if you want to do even better than an index fund, you probably can. Though most managed mutual funds don't beat index funds, many do. It's just a matter of finding the right funds. I've written about promising funds in the past, as have some colleagues:
- 3 Mutual Fund Winners
- Trust This Fund
- 24 Promising Mutual Funds: Part 1 and Part 2
- A Sturdy Fund Reopens
- A Tale of Two Funds
- 3 Tasty Fund Plays
You can also learn a lot about investing in mutual funds by reading through our Mutual Fund area and these articles by Shannon Zimmerman:
But before you invest in any mutual fund, make sure you've studied it well -- either on your own or with some help. We'd love to help you, via our MotleyFoolChampion Funds newsletter, which you can try for free. Take advantage of a free trial, and you'll see all the funds that Shannon Zimmerman has recommended, based on a lot of research that he presents in the newsletter. You can also see how they've fared since being recommended. (Hint: pretty well.)
Go get 'em, Fool!
Longtime Fool contributor Selena Maranjian 's favorite discussion boards include Book Club , The Eclectic Library, and Card & Board Games . She owns shares ofBerkshireHathaway. For more about Selena, viewher bio and her profile. You might also be interested in these books she has written or co-written:The Motley Fool Money GuideandThe Motley Fool Investment Guide for Teens. The Motley Fool is Fools writing for Fools.