Does the little guy ever really stand a chance in the market? Well… did David take down Goliath?
The mainstream media likes to peddle stories about the little investor who always loses money in the stock market. When the mechanics or teachers or dentists of this world try to compete with the big boys on Wall Street, they always seem to fail. Ordinary people like you and me appear doomed to lose our shirts when we try to compete against folks with sophisticated trading tools (and mathematical geniuses to run them). But are we?
This Call May Be Recorded for Training Purposes
Professionally managed mutual funds usually fail to beat the S&P 500. In the May issue of Money Forever, which focused on minimizing unnecessary fees in one’s portfolio, we shared some noteworthy statistics with our subscribers:
“Actively managed mutual funds just don’t have the best track record, largely because of the high fees. Over the last five years:
- 65.44% of active, large-cap fund managers failed to outperform the S&P 500
- 81.57% of mid-cap managers lagged behind the S&P Midcap 400
- 77.73% of small-cap managers were outperformed by the S&P SmallCap 600″
Ouch! Not a great record considering the fees they’re raking in.
When I think back on the many times I spoke with stockbrokers who wanted my business, they always implied that I needed professional investment help – their help. When I’d mention statistics like the ones above, stockbrokers would jump on them as further proof that the little guy doesn’t stand a chance on his own. If those genius fund managers can’t beat the S&P, how could I?
I recall asking one overly aggressive broker why he was wasting his time with me. I told him, “If you are so damn good, you could make a lot more money managing a fund yourself.” He was so naïve that he thought I was serious. When I realized I was getting an earful about his career aspirations, I quietly hung up the phone. That is one call I hope his employer recorded for training purposes.
The implied promise from the mutual fund industry and their co-conspirator brokers is that, in exchange for high fees, they will deliver a better performance than the overall market – better than you could produce on your own. It’s a great theory, but few (if any) funds consistently outperform the market.
There are multiple reasons why their promises never pan out. First, the larger a fund gets, the harder it is to deliver. When the fund grows into billions of dollars, it must keep investing, either deeper into positions it already has or by widening its base with additional picks. At a certain point, the greater size becomes a disadvantage. The fund loses a lot of flexibility.
Managers of large funds are under constant pressure to grow their funds as they make more money. Many of the funds with larger fee structures use some of those fees to compensate stockbrokers. Sure, the funds may do well before fees are applied, but once everyone takes his cut, the picture isn’t quite as rosy. At that point, folks are better off buying an exchange-traded fund (ETF) based on an index with much lower fees, all from the convenience of their home computers.
I recently watched a Frontline special on retirement, which highlighted just how much these fees impact our portfolios. The producers suggested that fees are a major cause of the poor performance of many 401(k) accounts. While fees are certainly a major reason why the financial industry fails to deliver on so many of its promises, I want to focus on another issue today.