AssetBuilder Inc. Registered Investment Advisor - Simple Investing. Smart Future.

I very close to retirement and will be receiving a lump sump for my retirement.  In talking to several money managers, they naturally suggest that actively managed accounts including their higher fees will out do the index accounts (ie Asset Builder-DFA Funds.)   I just look at my long term S&P 500 IRA fund and have a hard time argueing with them. 

Having read "Wealth without worry," it would be nice to belive in the indexed accounts, but with the stock marked up and down for the last 10 years, I wonder.  Except for the decision to retire, where to put my money in retirement will be the next most important financial decision for my family.

In Scott Burns many articles, he states that active managers for mutual funds generally don't do much better than index funds, however I have noticed that at least 50% of mutual funds are doing better than the S&P 500.   Question:  are there long periods of time when active management is better than index management?

Captain Dan:

In Scott Burns many articles, he states that active managers for mutual funds generally don't do much better than index funds, however I have noticed that at least 50% of mutual funds are doing better than the S&P 500.   Question:  are there long periods of time when active management is better than index management?

To a certain extent you are comparing apples to oranges when you pair the S&P 500 against actively managed funds.  The S&P is a relatively narrow and focused group of stocks when the actively managed funds range over the entire world and include all asset classes.

A better comparison would be a "couch potato" or DFA recommended portfolio against a similar asset allocation among actively managed funds.  Here you still have the problem of picking which actively managed funds to use as comparison.  I can easily pick the absolute winners among the actively managed funds as can any prospective financial advisor you speak with.  If you pick the "average" fund, indexing will almost certainly win but any good FA will say they can beat the average. 

You will ultimately have to have faith in the process of indexing or you will never be safe from the siren's call of actively managed funds.  Someone will always beat whatever index allocation you are tracking.  Unfortunately, no one can really tell who these winners will be until after it happens. 

A problem Scott has mentioned in the past is survivor bias. 

Suppose on January first that Fidelity started 100 new actively managed large cap funds, and that the active management consisted of picking ten stocks for each fund from the S&P 500 by the dart board method.  

At the end of the year you would reasonable expect half of the "actively managed" funds to be ahead of the S&P 500, and the other half to trail.  Now just take the bottom half of the funds out of business, and Fidelity can "honestly" say that all fifty of their existing funds beat the S&P 500 last year.

Figures don't lie, but liars figure.

Bryan

The best way to get a grip on this is to read one of the SPIVA reports, a quarterly report from Standard & Poor's that measures the performance of managed funds against major indices. Unlike most reporting, this one adjusts for survivor bias. Here's a link to the most recent report: http://www2.standardandpoors.com/spf/pdf/index/SPIVA_2007_q1.pdf . As you'll see from the report, active management doesn't come out very well and they are only measuring a 5 year period. The longer the time period, the greater the odds that the index fund will beat managed funds.

Over the last 15 years, for instance, Morningstar shows that both the Vanguard Total Market Index fund and the Vanguard 500 Index fund were in the 34th percentile for large cap blend funds--- and their data doesn't adjust for survivor bias.

This report verifies research I have been tracking since the early 70s. This research, done by a multitude of different parties, has consistently concluded that about 70 percent of all active managers fail to beat their appointed index benchmark. This doesn't mean the 70 percent figure is consistent, it actually moves up and down over long cycles. But the general range is from about the 50th percentile to the 90th.

In rising markets the index funds have an advantage over managed funds because they have little or no cash so they get 100 percent of a rising market. In declining markets the index funds have a disadvantage for the same reason--- while active funds hold more cash and are slightly less vulnerable to declines, index funds feel the full drop.

Scott

Does anyone here have any comments about the Hulbert ranking/index of newsletters that dispense  "managed" portfolio advice/trends/investment picks?