Tiger Woods was awesome. Before his 33rd birthday he had won 14 major golf championships. Jack Nicklaus held the record at 18 majors. Woods was closing fast. But then something happened. Tiger Woods stumbled. He’s now trying to recover but his rivals are tough. It might be hard to believe, but 779 players are currently ranked ahead of him. Legendary golfer Johnny Miller says, “It’s crowded at the top.” In the past, he says, it was easier for great players to stand out.
That goes for most sports–and for actively managed mutual funds. In the past, it was easier for a good fund manager to beat the market. If a manager knew that small stocks, value stocks and high quality stocks with momentum often beat the index, that fund could win. These are called factor-based premiums. They’re like refined golf swings. But the days of applying them and whipping people have gone the way of wooden clubs. They’re no longer winning weapons.
In The Arithmetic of Active Management, Economic Nobel Prize Winner William F. Sharpe says the average actively managed stock market dollar will earn the market’s return. Here’s what that means. If the stock market gains 8 percent, including dividends, the typical actively managed stock market dollar would have earned about 8 percent, before fees. To gain an edge, an active fund manager must beat his or her peers. But like Tiger Woods’ competition, those peers keep getting better. The only way to guarantee that you’ll beat most of the pros is with a low-cost index fund.
American Funds is a fabulous actively managed fund company. But they want you to invest based on what they used to do. That’s like betting money on Tiger Woods today.
The firm’s website displays a championship-winning chart. Five of its actively managed funds trounced the S&P 500 between 1976 and 2016. It says, “So the next time you hear ‘You can’t beat the index’ consider American Funds long-term track record.”
Look closely at that chart. It appears that their funds are pulling further and further ahead of the stock market index. But let’s draw back the curtain. Recent scores aren’t as strong as that colorful graphic claim.
Vanguard’s S&P 500 vs. American Funds
1976-2016
Source: American Funds from Capital Group
I averaged the returns of these winning mutual funds to April 14, 2017. According to Morningstar, Vanguard’s Total Stock Market Index (VTSAX) beat them over the past 1, 3, 5, 10, and 15-year periods.
Vanguard’s Total Stock Market Index vs. American Funds
Compound Annual Returns - Ending April 14, 2017
| 1 Year | 3 Years | 5 Years | 10 Years | 15 Years | |
|---|---|---|---|---|---|
| American Funds Growth Fund Of America (AGTHX) | 16.44% | 11.21% | 14.03% | 7.22% | 8.05% |
| American Funds AMCAP Fund (AMCPX) | 11.17% | 9.13% | 13.15% | 7.67% | 7.59% |
| American Funds Washington Mutual Investors (AWSHX) | 13.55% | 9.42% | 12.87% | 6.52% | 6.90% |
| American Funds Investment Company of America (AIVSX) | 13.78% | 9.92% | 13.37% | 6.51% | 7.20% |
| American Funds America Mutual Fund (AMRMX) | 12.61% | 9.18% | 12.06% | 6.67% | 7.15% |
| American Funds Average | 13.51% | 9.77% | 13.09% | 6.91% | 7.37% |
| Vanguard Total Stock Market Index Admiral (VTSAX) | 14.89% | 10.39% | 13.42% | 7.28% | 7.72% |
*Compound annual average returns — Source: Morningstar.com
According to the SPIVA Scorecard, index funds trounced most actively managed funds over the past 15 years. Indexes beat 92.15 percent of large-cap funds. Only one of the American Funds managed to keep pace.
But when we add its 5.75 percent sales commission that one lost too. A $10,000 investment in the American Funds Growth Fund Of America (AGTHX) would have grown to $29,980 over the past 15 years. The same investment in Vanguard’s Total Stock Market Index Admiral Shares (VTSAX) would have grown to $30,510.
The active fund falls further behind when we consider monthly contributions. If $500 were invested monthly in the American Funds top-performing fund it would have grown to $220,357 during the 15-year period ending March 31, 2017. If it were invested in Vanguard’s Total Stock Market Index Admiral (VTSAX) it would have grown to $235, 249.
Tiger Woods might win another major championship. American Funds might also pull off the odd surprise. But in both cases, their dominant days are now well behind them.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and The Global Expatriate's Guide to Investing: From Millionaire Teacher to Millionaire Expat.