Index Funds Lag for 7th Straight Year

Vanguard did a good job of convincing people to buy into their S&P 500 index fund, but was that advice wise? Jack Bogle, the company’s founder and most outspoken advocate, seems to make a decent case for Vanguard.

After getting crushed by their technology stock centric portfolios from 2000 through 2002 (The Nasdaq fell 80%), investors should just move what’s left of their nest egg into index funds. After all, few actively mutual managed funds can consistently beat the overall market indices. Why pay 1.5% per year for a lackluster managed fund when you get pay 90% less for Vanguard Index 500?

Not only do we hear this logic all the time, but millions of people have adopted the strategy. What do they have to show for it? Not much, according to Lipper, a leading tracker of mutual fund perfomance. For the 7th straight year actively managed U.S. stock mutual funds beat the S&P 500 index funds that have been marketed so heavily since the bubble burst.

So far this decade the S&P 500 has averaged a return of 0.2 percent per year. Actively managed frunds have returned 3.5% annually for their investors during the same time period. Some people may be surprised to learn this, but is it really that shocking? If active managers can’t beat a 0.2% return, that would be pretty pathetic. Still, annual gains that barely outpace inflation are certainly nothing that active mutual fund owners should feel all that happy with, so don’t think these funds are all of the sudden your best way to make good money.

The index fund argument completely ignores the entire point of investing; to buy low and sell high. To do so, investors must purchase attractively priced stocks, wait until they trade closer to fair value, and sell them. Then the process repeats itself. How does owning every stock in the country via an index fund accomplish this feat? By definition, it won’t. You’ll own undervalued stocks, fairly valued stocks, and overvalued stocks. Basically, you’re just crossing your fingers and hoping the stock market goes up. Too bad the bull market ended six years ago.

I don’t know about all of you, but banking your retirement on the hope that the market will go up is a risky proposition. Getting superior returns from index funds will solely depend on whether or not you happen to own them during bull markets or not. Unfortunately for investors, the greatest bull market in history ended in 1999. Pretty ironic considering that actively managed funds have outperformed the S&P 500 each and every year since, you guessed it, 1999.