Buying Actively Managed Mutual Funds Is Dumb

Buying Actively Managed Mutual Funds Is Dumb
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If you’re hoping to achievement the happy retirement reflected in this photo, and you’re investing in actively managed mutual funds, I don’t like your chances. Sorry to be so blunt, but buying these funds is dumb— really dumb. Here’s why.

Undisclosed conflicts and more

Don’t be bamboozled by all the confusing talk about the “fiduciary rule”, promulgated by the Department of Labor, and now delayed by the Trump administration. It makes absolutely no sense to entrust your savings to anyone who who won’t agree, in writing, to fully disclose all conflicts of interest and to always place your interest above both theirs and their firm’s.

Every registered investment advisor is required by law to do so. Brokers are not. They can, and often do, have undisclosed conflicts of interest and are permitted to recommend investment products that are more expensive and more profitable for them than lower cost, comparable products, as long as their recommendation is deemed “suitable” for you.

Brokers use this loophole to recommend actively managed funds, even though they are aware of the overwhelming data indicating these funds are likely to underperform far less expensive, comparable index funds — especially over the long term.

You don’t want to invest in “suitable” products. You should insist on recommendations that are solely in your best interest, which means that costs and fees are taken into account.

The one question every broker dreads

In 2016, there was a shift from active into passive (index-based) investments of almost $1 trillion. Clearly, the smart money isn’t buying the purported ability of brokers to prospectively select outperforming, expensive, actively managed mutual funds.

Here’s the question I want you to ask your broker when he or she recommends actively managed mutual funds: What are the odds this fund will beat the returns of a comparable index fund over a 10 and 20-year period? It’s important to insist on a response in writing.

Here’s what’s likely to happen: You’ll never get one. The broker will have a lot of excuses (like “my compliance department won’t let me”), but the real reason for dodging this question is because the answer is devastating to the business model of brokers. They understand that, if you knew the data, you wouldn’t own any actively managed mutual funds.

At the beginning of 1998, there were 1,540 actively managed U.S. domestic stock funds;

  • Only 55% of them survived the ensuing 15-year period;
  • Only 18% of the survivors outperformed their benchmarks;
  • 97% of the outperforming funds unperformed their benchmark in at least 5 years of the 15-year period studied.

Here’s what this data tells you (and what your broker hopes you won’t learn). Your chance of selecting an outperforming mutual fund over a long period of time is exceedingly small. Even if you are successful, you will have to hold on to the fund for a number of years of underperformance. It will be a rocky ride, with an uncertain result.

The road to reaching your retirement goals is paved with low management fee index funds. The road to your broker reaching his or her retirement goals depends on persuading you to buy expensive, actively managed funds.

The views of the author are his alone. He is not affiliated with any broker, fund manager or advisory firm.

Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.

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