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Yale's legendary investment guru, David Swensen, shreds the mutual-fund industry this weekend in The New York Times.
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Swensen points out what anyone who has objectively studied the facts of investing inevitably comes to realize: The fund industry costs investors billions in lost returns every year — while coining money for itself, its employees, and its distributors.
The primary promise of the traditional for-profit fund industry — that it's smart to pay a star fund manager huge money to pick stocks for you — is blown apart by performance data, which shows that the vast majority of funds lag low-cost index funds every year. And the minority of funds that beat index funds this year — about a third in most years — won't likely beat them next year or the following year.
Meanwhile, urged on by misleading "quality" rankings, investors consistently choose to invest in funds that have done well in the past, not funds that are likely to do well in the future.
Specifically, year in year out, investors buy funds that have been given 4 and 5 stars by Morningstar and withdraw money from funds that have been given 1 and 2 stars. They do this despite the fact that even Morningstar admits that the ratings aren't predictive — that 4 and 5 star funds aren't likely to do any better in the future than 1 and 2 star funds.
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What is predictive?
Costs.
The lower the cost of a fund, the more likely it is to do well in the future (relative to other funds). The higher the cost, meanwhile, the less likely the fund is to do well. This is one reason that index funds outperform "actively managed funds" (funds with managers paid to pick good stocks and sell bad ones) year after year: The manager's salary is deducted from the fund's returns, and most managers aren't good enough to offset the cost of their salaries and their employer's profits.
Why don't financial advisors tell their clients these simple facts?
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Because financial advisors like to believe (or pretend) that they can add more value than that — that their acumen and relationships and experience will allow them to select funds that do "better than average." (Even though index funds do distinctly better than average.) And also because financial advisors are often incented (paid) to recommend certain funds over other funds — and the commissions on high-cost funds are generally higher than those on low-cost index funds.
These observations aren't theories, by the way. They're demonstrable facts. If every American who owns a high-cost, actively managed mutual fund sold it and bought a low-cost index fund, the average returns of America's investors would rise considerably — in part because American investors wouldn't be paying billions of dollars of fees each year to mutual fund companies to lose money for them.
Read David Swensen's article at The New York Times >
Note: I realize this sounds harsh and disrespectful to the many great people who work in the for-profit mutual fund industry, some of whom are my friends. It isn't meant to be disrespectful. Some funds — a very small percentage — do outperform indices over the long haul. Some fund managers do actually have an edge. Unfortunately, the vast majority don't.
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The fact is that the clients of most traditional mutual funds would be considerably better off if the fund employees just shut their firms down, re-allocated their client's money to low-cost index funds, and found other work to do. Equally unfortunately, however, the other work would likely pay significantly less well than the for-profit mutual-fund industry — which is why so few of the folks in the industry do the work necessary to understand these realities.
Executive Chair and Co-Founder
Henry Blodget is cofounder and Executive Chair of the Board of Insider Inc. He is also an occasional columnist (see below).Business Insider is a global journalism organization with more than 700 staff members and offices and affiliates in more than 17 countries. Insider's publications and programming reach more than 300 million people worldwide each month.Henry started Insider Inc., then called "Silicon Alley Insider," in the loading dock of another New York-based startup in 2007. He served as CEO and Editor in Chief until 2017. Insider was initially funded by RRE Ventures, Institutional Venture Partners, Jeff Bezos, and other investors. Insider Inc. is now owner by Axel Springer, the leading digital publisher in Europe.A former top-ranked Wall Street analyst, Henry is often a guest on CNBC, CNN, MSNBC, NPR, and other networks. He has contributed to The Atlantic, Slate, The New York Times, Fortune, New York, the Financial Times, and other publications. He has written extensively about technology and investing and is the author of "The Wall Street Self-Defense Manual: A Consumer's Guide to Investing." During the dot-com boom of the late 1990s, Henry was a top-ranked Wall Street internet analyst. He was later keelhauled by then-Attorney General Eliot Spitzer over conflicts of interest between the research and banking divisions of brokerage firms.Henry received a B.A. from Yale University. He was born in New York.Disclosure: Henry believes that frequent trading is a lousy investment strategy for individual investors. He primarily invests in a portfolio of low-cost, tax-efficient index funds. This said, as a legacy of his days as a stock analyst, Henry also has positions in stocks like Amazon, Apple, Microsoft, and other companies. Henry is also an investor in Business Insider.
Executive Chair and Co-Founder
Henry Blodget is cofounder and Executive Chair of the Board of Insider Inc. He is also an occasional columnist (see below).Business Insider is a global journalism organization with more than 700 staff members and offices and affiliates in more than 17 countries. Insider's publications and programming reach more than 300 million people worldwide each month.Henry started Insider Inc., then called "Silicon Alley Insider," in the loading dock of another New York-based startup in 2007. He served as CEO and Editor in Chief until 2017. Insider was initially funded by RRE Ventures, Institutional Venture Partners, Jeff Bezos, and other investors. Insider Inc. is now owner by Axel Springer, the leading digital publisher in Europe.A former top-ranked Wall Street analyst, Henry is often a guest on CNBC, CNN, MSNBC, NPR, and other networks. He has contributed to The Atlantic, Slate, The New York Times, Fortune, New York, the Financial Times, and other publications. He has written extensively about technology and investing and is the author of "The Wall Street Self-Defense Manual: A Consumer's Guide to Investing." During the dot-com boom of the late 1990s, Henry was a top-ranked Wall Street internet analyst. He was later keelhauled by then-Attorney General Eliot Spitzer over conflicts of interest between the research and banking divisions of brokerage firms.Henry received a B.A. from Yale University. He was born in New York.Disclosure: Henry believes that frequent trading is a lousy investment strategy for individual investors. He primarily invests in a portfolio of low-cost, tax-efficient index funds. This said, as a legacy of his days as a stock analyst, Henry also has positions in stocks like Amazon, Apple, Microsoft, and other companies. Henry is also an investor in Business Insider.
