A couple of years ago, I paid five Canadians to each walk into a different Canadian bank. They were armed with iPhones to record their conversations. Here’s what I asked them to say to a financial advisor:
“I would like to build a portfolio of index funds. Could you help?”
Most Canadians invest through one of five big banks. Each bank offers its in-house versions of index funds. They aren’t cheap, compared to the index funds available to American investors. But the Canadian banks’ index funds (which charge about 1 percent per year) are a heck of a lot cheaper than Canada’s actively managed funds.
It’s easy to gripe about the high cost of actively managed funds in the United States. David Swensen, Yale University’s endowment fund manager says, “The Mutual Fund industry’s systemic exploitation of individual investors requires government action.” And that might be true. But compared to investors around the world, Americans get a deal. Here’s what happened to those five young people who walked into Canada’s banks.
In every case, the advisors told them not to buy index funds. They recommended the bank’s actively managed funds instead. On average, the portfolios that the advisors recommended would have cost these investors 2.5 percent per year.
Smart investors know that it’s tough to beat the market – especially after fees. According to the SPIVA scorecard, the U.S. stock market index beat 85.93 percent of American-sold actively managed funds over the 10-year period ending June 30, 2018. That’s bad news for the Americans who buy actively managed funds. But results are even worse for non-American investors.
Morningstar’s Director of Research Russel Kinnel says, “Fees are the best predictor of mutual fund performance.” Mr. Kinnel was referring to the performance of U.S.-sold funds. But if he compared country-to-country, he could have said the same thing.
Several countries, including Canada, sell actively managed funds that focus entirely on U.S. stocks. We can compare such funds to the U.S. stock index. Over the 10-year period ending June 30, 2018, a whopping 97.67 percent of Canada’s actively managed U.S. stock market funds underperformed the U.S. stock market index.
In Europe, actively managed funds are also more expensive than they are in the United States. According to Morningstar, countries like Belgium, Spain, Italy, Germany, Finland and France have mutual fund costs that are almost as high as Canada’s. That’s why the U.S. stock market index hammered a shocking number of European-sold, actively managed U.S. stock market funds. According to SPIVA, 97.76 percent underperformed the U.S. stock market index over the 10-year period ending June 30, 2018.
America’s Actively Managed Funds Are Among The World’s Best
Percentage Of Actively Managed Funds That Lost To The U.S. Index
June 30, 2008-June 30, 2018
|Country’s U.S. Stock Market Funds||Average Cost Of Actively Managed Funds||Percentage That Underperformed The U.S. Index|
|Sources: Morningstar, SPIVA Scorecard, mid 2018
*This is non-asset weighted. When measuring asset-weighted averages, most Americans pay less than 1% for their actively managed funds. This is not the case for mutual fund investors outside the United States.
This doesn’t mean foreign mutual fund managers aren’t smart people. Their funds’ fees are just expensive; high costs hurt returns.
Fund fees, after all, are the best predictors of success. But it’s tough to beat an index, even with the world’s cheapest active funds. For example, Vanguard offers several actively managed funds. They charge as little as 0.22 percent per year. But Vanguard’s index funds still give most of them a beating.
I compared the company’s actively managed funds to their benchmark index funds. I only selected funds with 15-year track records. On average, 67 percent of them lost to their benchmark index funds before taxes. After taxes, the actively managed funds did even worse. In a taxable account, about 83 percent would have underperformed Vanguard’s index funds over the past 15 years. You can read about that here.
Vanguard’s Actively Managed Funds vs. Index Funds
Ending February 28, 2019
|Category||Fund||Expense Ratio||Pre-Tax Annual Return||Annual Turnover||Post-Tax Annual Return|
|Actively Managed||U.S. Small Cap Stocks||Vanguard Explorer (VEXPX)||0.46%||9.01%||50%||7.48%|
|Passively Managed||Comparable Index||Vanguard Small Cap Index (VSMAX)||0.05%||9.39%||15%||8.98%|
|Actively Managed||U.S. Growth||Vanguard U.S. Growth (VWUSX)||0.38%||8.83%||33%||8.2%|
|Passively Managed||Comparable Index||Vanguard Growth Index (VIGRX)||0.17%||8.89%||11%||8.61%|
|Actively Managed||U.S. Value||Vanguard Windsor (VWND)||0.31%||6.89%||33%||5.72%|
|Actively Managed||U.S. Value||Vanguard U.S. Value (VUVLX)||0.22%||6.88%||75%||5.80%|
|Passively Managed||Comparable Index||Vanguard Value Index (VIVAX)||0.17%||7.9%||8%||7.33%|
|Actively Managed||Health Care||Vanguard Health Care (VGHCX)||0.38%||10.86%||11%||9.24%|
|Passively Managed||Comparable Index||Vanguard Health Care Index (VHCIX)||0.10%||10.02%||6%||9.71%|
|Actively Managed||International Stock||Vanguard International Explorer (VINEX)||0.39%||7.41%||40%||6.13%|
|Passively Managed||Comparable Index||Vanguard International Index (VGTSX)||0.17%||5.43%||3%||4.71%|
|Source: Morningstar.com, returns ending February 28, 2019
Note: These represent all of Vanguard’s actively managed funds from which the following applied: They have 15-year track records that could be compared to Vanguard’s equal asset class index funds. They also include only the funds with estimates for after-tax performances, as published by Morningstar.
Americans might have the world’s best actively managed funds. But, that doesn’t mean you should buy them. Vanguard, Schwab and Fidelity offer index funds that cost a lot less. DFA’s funds are in a similar low-cost league. That’s why it doesn’t make sense to buy actively managed funds.
For further related reading
- What Can We Learn From The World’s Worst Financial Advisors?
- Why Index Funds Have Tax Advantages
- Why Fees Matter
- Should You Add Some Actively Managed Funds To Your Portfolio of Indexes?
- Fidelity’s Zero-Fee Index Funds Are A Perfect Fit For Kids
Andrew Hallam is a Digital Nomad. He’s the author of the bestseller, Millionaire Teacherand Millionaire Expat: How To Build Wealth Living Overseas