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Are You Falling Victim to Wall Street's Dark Secret?

Seth Jentner03/13/2014

There is a disappointing story about the investment profession that some have called Wall Street’s dark secret: Academic research shows that a majority of managers do not beat the markets.

Indexed investing has gotten a bad rap from active managers out to protect the high fees they earn from buying and selling investments. However, plenty of academic research suggests that passively engineered managers who buy a portfolio that matches a market index (or that represent an entire investment asset class) tend to perform better over time than the majority of active investors who try to beat the market by either selecting the “right” investments or by timing when to buy and sell.

Each year, the Standard & Poor’s Indices Versus Active Scorecard, known as SPIVA, is published. SPIVA tracks the performance of stock-market and bond-market indexes compared to the performance of active fund managers over the past decade. Once again, the results have given strong backing to passively engineered investment management.

Active managers have long argued that they do better during bear markets because they have flexibility. Unlike passive managers, who must continue to be fully invested, active managers can buy and sell and play defense. But in the two bear markets covered by the recent SPIVA scorecard, the majority of active fund managers failed to beat their index benchmarks.

In Greek mythology, the Sirens, dangerous creatures portrayed as beautiful women who lured nearby sailors with their enchanting music and voices, would cause sailors to shipwreck on the rocky coast of their island. Odysseus, warned about the destructive lure of the Sirens, had his sailors put wax in their ears so that they could not hear the enchanted singing

In like manner, be careful of the investment pitch that promises little risk and high returns. This may be a song of the Sirens and may cause you to shipwreck your investment portfolio as you attempt to enjoy the improbable.

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