Here's Yet Another Reason to Avoid Fund Managers, According to Graham Stephan

Index funds just do better more often.

Graham Stephan is an American real estate agent and YouTube personality famous for his personal finance and investing advice. He recently unveiled his 2023 investment plan, which includes a hefty allocation to the $SPY, a passive index fund that tracks the S&P 500.

The finance guru prefers passive funds over actively managed funds. Actively managed funds choose stocks based on research, analysis, and timing. They are not pegged to market indexes; instead, fund managers run them.

Stephan recently gave investors yet another reason to avoid fund managers.

Most active funds underperform the market

On Twitter, Stephan said, "Two-thirds of active fund managers were beaten by the index in the last 20 years. Of the remaining third, managers that win in one year don't win in the next year most times."

Independent research supports his claim. According to one report by S&P Global, actively managed funds have mostly underperformed index funds like the S&P 500. The report compares active funds to the S&P 500. Here are some 2022 numbers:

• More than 50% of U.S. large-cap funds underperformed over one year.
• More than 86% of U.S. large-cap funds underperformed over five years.
• More than 94% of U.S. large-cap funds underperformed over 20 years.

What does this mean? Stephan may be understating how many poorly fund managers perform over the long term.

Why do fund managers underperform?

Fund managers may underperform passive funds for several reasons. They typically charge high fees, which eat into investor returns. Fund managers may make poor investment decisions or prioritize short-term returns. The list goes on.

Actively timing the market is risky business. Though a small percentage of active funds outperform the market, most don't. Passive funds are less risky investments.

Where should you invest your money?

Stephan advocates pouring your money into index funds and forgetting about it. It's a simple and profitable strategy. The stock market's record speaks for itself: It has returned an average of 10% per year over the past 50 years.

Stephan recommends investors diversify their investments. Index funds automatically spread out investments among companies. As part of his 2023 investment strategy, the finance guru diversified some of his portfolio into real estate, Treasuries, and a tiny bit into Bitcoin and Ethereum. If a single market crashes (like the crypto market), his entire portfolio might not be down.

Another strategy for weathering a tough market is to build an emergency fund. You can pull from a savings account to cover unexpected expenses like medical bills or credit card debt. An emergency fund protects you from selling stocks at a loss -- or taking out pricey loans.

Best stock brokers

Stock brokers offer investors a place to buy and sell stocks for cheap. The best stock brokers demolish fees and make investing easy. Even beginners can invest in individual stocks or passive funds like the S&P 500 through beginner-friendly brokers.

Investors should be wary of investing through fund managers, who charge high fees. Passive index funds are stable and profitable alternatives that charge lower fees. Consider your risk tolerance when picking a long-term investment strategy.