About 27 years ago, investment columnist Scott Burns created the Couch Potato Portfolio. Like many great ideas, it was elegant and simple. It was a split between a stock market index and a bond market index. Like Dorothy in The Wizard of Oz, Scott Burns pulled the curtain back on Wall Street and its brokers.
Between January 2001, and September 30, 2018, it would have earned a compound annual return of 8.30 percent. That would have turned a $10,000 investment into almost $92,000.
Brokers have been fighting Scott’s wisdom for years. They say you can’t beat the market with an index fund. That’s true, but most actively managed funds can’t beat the market either.
According to the SPIVA U.S. Scorecard, during the 15-year period ending December 29, 2017, the S&P 500 beat 92.33 percent of actively managed large-cap funds. The S&P Mid-Cap 400 Index beat 94.81 percent of actively managed mid-cap funds. The S&P Small Cap 600 Index beat 95.73 percent of actively managed small-cap funds.
Some active managers do beat the market. But it’s almost impossible to find them in advance. Funds that win during one time period usually disappoint the next. In March 2016, the S&P Persistence Scorecard tracked 557 top-performing funds. Each fund had performed among the top 25 percent of actively managed funds over three consecutive 12-month periods. But by March 2018, using the same criteria, just 2.33 percent of them remained among the top 25 percent.
Last year, Scott told me that the debate between index funds and actively managed funds is over. And he’s right. But many brokers continue to hang on to the active myth. They might say, “Index funds are fine. But you take bigger risks if you don’t have active funds too.” They claim such funds can protect investors when stocks fall. It’s a great fear tactic. But it simply isn’t true.
The S&P 500 has had three losing years since 2001.
In 2001, the index dropped 11.89 percent. Most actively managed funds, however, couldn’t protect investors. According to the SPIVA U.S. Scorecard, the S&P 500 beat 65.16 percent of large-cap actively managed funds.
In 2002, stocks suffered heavy bleeding. The S&P 500 plunged 22.10 percent. But the S&P 500 beat 67.73 percent of large-cap actively managed funds that year.
In 2008, investors suffered one of history’s worst calendar year crashes. The S&P 500 dropped 37 percent. But nearly 65 percent of actively managed U.S. stock market funds underperformed their benchmark indexes.
Indexes Beat Actively Managed Funds During One Of History’s Biggest Market Crashes
|Fund Category||% Of Actively Managed Funds That Lost To Their Benchmark Indexes In 2008|
|All Multi-Cap Funds||70.14%|
|All Small-Cap Funds||83.30%|
|All U.S. Equity Funds||64.91%|
|Source: SPIVA U.S. Scorecard|
Smart investors know that actively managed funds don’t reduce risk. Instead, diversification does. That’s why investors should stick to a diversified portfolio of low-cost index funds. No matter what your broker says, there’s no room in your portfolio for an actively managed fund. I think Scott Burns would agree.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas