Facts are stubborn things. The Prudent Investor considers the facts when deciding between investment options and between investment advisors. Standard & Poors provides two sets of facts that are critical in the decision making process about investments. The first study is linked below.
Standard & Poors has now become the de facto scorekeeper for the debate between the active stock pickers and market timers and the passive index type funds. Over annual periods, there is no clear winner of active vs. passive. However, over five year periods, index funds are the clear winner. Page seven of the report below shows that index funds beat 61.88% of all domestic equity funds. When the report breaks down the funds into different asset classes, the indexes beat some active fund categories by 70%, 80% and even 90%.
DOES PAST PERFORMANCE MATTER?
"Looking at longer-term performance, 5.97% of large-cap funds with a top-quartile ranking over the five years ending March 2007 maintained a top-quartile performance over the next five years. Only 4.35% of mid-cap funds and 15.56% of small-cap funds maintained a top-quartile performance over the same period. Random expectations would suggest a repeat rate of 25%” (Emphasis Added)
Comments: Just about everybody does it – We look to the past performance of an investment manager or mutual fund as one of the most important investment decision criterion. The facts tell us not to do that. Coin flipping works better.
Past performance compares active managers with other active managers. The winners of the past five years are not likely to be the winners over the next five years.
The S&P facts also tell us that most active investment managers and mutual funds do not perform as well as their benchmarks. Those facts lead the Prudent Investor toward passive funds or index funds that perform more like the benchmarks. If you can’t beat the benchmark, invest like the benchmark.
Every prudent investor should require their financial advisor to explain how their advice deals with these stubborn facts.