Investing and gambling share at least one common thread; it’s all about odds. And depending on how you build your portfolio of investments, you will either increase or decrease your odds of investment success.
The latest data from Morningstar’s Active/Passive Barometer illustrates how investors that buy actively managed mutual funds are decreasing their odds of receiving satisfactory performance returns.
Exhibit 1 shown below illustrates this point. Did you notice how in the 12 investment categories tracked by Morningstar (highlighted in yellow), the success ratio of active managers over a 10-year time horizon was less? In other words, passive index benchmarks outperformed active managers!
During the past 10 years, the investment categories where active managers had the lowest rate of success in beating their index benchmark was in the U.S. mid-cap blend (NYSEARCA:MDY), U.S. large-cap growth (NYSEARCA:IWF), and U.S. large-cap blend (NYSEARCA:SPY). In these three categories, between 78.4% to 86.3% of actively managed funds failed to outperform their corresponding passive index yardstick. Ouch!
Although U.S. mid-cap value stocks was the only category over the past decade where actively managed funds did outperform passive yardsticks (NYSEARCA:VOE), the margin of victory was slim. Just 54.4% of active mid-cap value funds beat their benchmark. In other words, active mid-cap value funds won not in a dominant way, but in a very unconvincing fashion.
This latest Morningstar data does not prove that investors need to pick their fund managers more carefully. Rather, it proves the odds of receiving satisfactory performance from active funds that match or exceed passive yardsticks in multiple investment categories, including bonds (NYSEARCA:AGG), is extremely low. This uncomfortable fact isn’t just true across most mutual fund categories, but it’s even more true as investment time horizons expand beyond 10-years.
The data further cements the proper place for actively managed funds within an investment portfolio, if you choose to even use them at all, is in a secondary role as non-core assets. It’s these non-core assets that make up just a minority portion of an investor’s total portfolio value, whereas the core or bulk of the portfolio is allocated to index ETFs invested across a variety of different asset classes.
In summary, buying index funds or ETFs in itself won’t guarantee satisfactory results. Many so-called index investors still receive sub-par performance results because they mis-time the market or have the wrong asset mix. Nevertheless, if you build the core of your investment portfolio with the right ingredients – passive index benchmarks – it’s a good start toward increasing your odds of investment success.
Ron DeLegge is the Founder and Chief Portfolio Strategist at ETFguide. Ron’s Portfolio Report Card grading system has been used to evaluate more than $100 million in portfolios and helps people to identify the strengths and weaknesses of their investment account, IRA, and 401(k) plan.
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