Two years ago, my 15 year-old nephew said, “Uncle Andrew, let’s have a race over 100 meters.” I lined up on the track beside my gangly six-foot tall nephew. I was 47 years old. Full of foolish pride, I thought I had a chance. But after just 20 meters, things weren’t looking good. I fought to the finish, hoping, against all odds, the young buck would wear out. But that didn’t happen.
Now imagine me saying this: “My nephew and I are going to race again. If you want to win some money, you should bet on me. After all, when I was fifteen years old, I ran faster times than my nephew can today. And three years ago, I would have left him in the dust.”
I hope this sounds crazy. I’m now two years older, and he’s two years stronger. But financial firms say things that are just as nuts. For example, in 2019, The Capital Group’s website asked a question that they also answered: Can I find [actively managed] funds that have beaten the index? I can.”
In this video, they compared the returns of the S&P 500 index to five actively managed American Funds since 1976. The actively managed funds look much better, based on a lead they built many years ago. But like me on that track, they’re no longer fast. By comparison, the index fund runs more like my nephew.
The S&P 500 beat the aggregate returns of these American Funds champions over the past 1-year, 3-year, 5-year, 10-year and 15-year periods. This wouldn’t surprise SPIVA. The data collection group stands for Standard & Poor’s Indices versus Active Management. Over the 15-year period ending June 30, 2019, the S&P 500 Index beat almost 90 percent of actively managed funds that invest in U.S. stocks.
What’s more, when an actively managed fund performs well, it has a shorter heyday than most people think. In September 2017, SPIVA identified 545 top-performing U.S. actively managed funds. Over the previous three 12-month periods, these 545 funds ranked among the top 25 percent of performers. But by September 2019, more than 500 of the top 545 funds no longer ranked among the top 25 percent, when comparing subsequent annual returns.
This brings us back to American Funds and the class A funds touted on their website. They charge higher expense ratio fees than Vanguard, Schwab or Fidelity’s index funds. And they gouge investors with an additional 5.75 percent load fee. In other words, when investors give $100 to their financial advisor, only $94.25 gets invested. The rest goes into the salesperson’s pocket. Even without this commission, the S&P 500 beat the aggregate returns of these funds over the past 1-year, 3-year, 5-year, 10-year and 15-year periods.
But when we slice off the commission, it looks even worse. Imagine investing $100 a month into Vanguard’s S&P 500 index, starting November 30, 2004. According to portfoliovisualizer.com, fifteen years later it would be worth $45,112. After fees, none of the American Funds would have kept pace.
American Funds Have Fallen Off The Pace
After-Fee Performances Assuming $100 Invested Per Month - November 30, 2004-November 30, 2019
|American Funds Growth Fund Of America (AGTHX)||$42,402|
|American Funds AMCAP Fund (AMCPX)||$41,837|
|American Funds Washington Mutual Investors (AWSHX)||$39,981|
|American Funds Investment Company of America (AIVSX)||$37,125|
|American Funds America Mutual Fund (AMRMX)||$37,725|
|American Funds Average||$39,814|
|Vanguard Total Stock Market Index Admiral (VTSAX)||$45,112|
In a taxable account, the gap would be even wider. After all, the American Funds have active traders at their helms. They buy and sell stocks every year. When they sell at a profit, their investors (in taxable accounts) have to pay the tax. It’s often a short-term capital gains tax, which penalizes investors more than the long-term capital gains tax rate.
By comparison, index funds rarely trade stocks. As a result, investors pay almost nothing in capital gains taxes until the day they sell. And when they do sell, it’s at the lower, long-term capital gains tax rate.
I might challenge my nephew to another foot race…if he has the flu. Like the actively managed American Funds, my fleet-footed racing is a thing of the past. That’s why it’s best to build a diversified portfolio of low-cost index funds.
For Further Reading
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas