Warren Buffett once said, “Only when the tide goes out do you discover who’s swimming naked.” According to the Employee Benefit Research Institute, 83 percent of American retirees among the bottom quarter of earners could run out of money during retirement. The outfit also figures that 25 percent of middle income earners might run out of money. Once they retire, these hard-working folks could be swimming naked.
John Bogle blames high mutual fund fees. Others blame low savings rates. But let’s not forget the peddlers on the beach. They’re selling would-be bathers plenty of financial pornography. These sexy pushers include brokers, financial planners and financial magazines. Too many of them pump the wrong kinds of mutual funds.
The industry is often flippant. Steve Forbes once said, "You make more money selling advice than following it. It's one of the things we count on in the magazine business -- along with the short memory of our readers."
Here’s an example from May 2010. U.S. News and World Report published, “The 100 Best Mutual Funds For The Long Term.” Each year, most finance magazines publish something similar. They should carry X-Rated warnings.
Kirk Shinkle’s opening line stated, “When it comes to choosing a mutual fund, there's nothing better than a solid track record.” This would shock most mutual fund academics.
It’s like saying, “When it comes to running on glass, there’s nothing better than a barefoot run.” For years, mutual fund experts have known that picking funds, based on their past results, can cause a lot of pain. Burton Malkiel, author of A Random Walk Down Wall Street, has been saying this for decades. John Bogle, the Vanguard founder and author of Common Sense on Mutual Fundsand The Little Book of Common Sense Investing says the same thing.
The SPIVA Persistence Scorecard, a publication from Standard and Poors’ gets published twice a year. It shows that the best performing funds rarely continue their winning ways. Morningstar’s research also says that past performance is a poor indicator of a fund’s future. Low cost, the firm says, is the best predictor of success. That’s why low-cost index funds are best.
“The 100 Best Mutual Funds For The Long Term,” listed 50 U.S. stock market mutual funds. U.S. News broke them into five different categories: Value, Growth, Small-Cap, Mid-Cap and Large-Cap.
The U.S. News and World Report article declared:
“Using our exclusive U.S. News Score, we've compiled lists of the best long-term performers in some of the most popular fund categories. We chose funds with positive 10-year trailing returns and, for stock funds, names that beat the S&P 500 over that time frame…Our score is based on the ratings of some of the mutual fund industry's best-known analysts, including Morningstar, Lipper, Standard & Poor's, TheStreet, and Zacks.”
A more accurate comment would have been:
“We have ignored financial academic studies. Instead, we chose yesterday’s winning funds and fortune tellers’ picks. Those purchasing these funds will likely underperform their respective benchmark indexes by an average of 2.31 percent per year. Over a 30 year period, a retirement nest egg’s potential could be reduced by a third.”
Where am I getting this 2.31 percent? I tore at the forecaster’s toga. I used portfoliovisualizer.com to see how these recommended funds performed since the article’s May 2010 publication.
Some of the funds changed names (as a result of poor performance, company mergers or acquisitions). But with the exception of the Madison Mosaic Disciplined Equity Fund, I tracked down every one. Keep in mind, these were market-beating funds when U.S. News had listed them.
The average returns of the recommended funds (in all five categories) lost to their benchmark indexes. The recommended value funds averaged a compound annual return of 8.77 percent between May 2010 and May 2016. Vanguard’s Value Index (VIVAX) averaged a compound annual return of 11.13 percent during the same time period.
The writer’s U.S. Growth fund recommendations averaged a compound annual return of 10.73 percent per year. Vanguard’s Growth Index (VIGRX) stomped them. It averaged a compound annual return of 12.35 percent.
The recommended U.S. Small Cap stock market funds really got thumped. They averaged a compound annual return of 8.39 percent per year. Vanguard’s Small Cap Index (NAESX) averaged a compound annual return of 10.79 percent per year.
The recommended Mid-Cap stock funds also dragged the market. They averaged a compound annual return of 9.71 percent. Vanguard’s U.S. Mid-Cap Index (VIMSX) averaged a compound annual return of 11.69 percent.
They also recommended 10 U.S. Large Cap funds. One is missing in action, so I averaged the returns of the nine that remain. As a group, they performed poorly. They averaged a compound annual return of 8.77 percent between May 2010 and May 2016. Vanguard’s Large Cap Index (VLISX) averaged a compound annual return of 11.73 percent. Vanguard’s S&P 500 Index (VFINX) averaged 11.86 percent.
On average, the five categories of recommended U.S. stock market funds underperformed their benchmark indexes by 2.31 percent annually over the six years ending May 2016. That’s worse than the typical actively managed fund.
Over the next six years, these funds won’t likely lag the market by 2.31 percent per year.
But that’s a mute point. Most of these funds won’t appear in a 2016 story of “Mutual Funds To Buy!” Many financial advisors will also pass them over.
Instead, they’ll find the funds that beat the indexes during the most recent year or decade. The cycle will repeat.
It’s no wonder so many retirees could soon be swimming naked.
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller Millionaire Teacher and Millionaire Expat: How To Build Wealth Living Overseas