Investors all over the world are under an illusion that if they ask enough questions, visit enough companies and set up a superior network of information sources, they can acquire superior information enabling them to achieve superior returns. This is referred as an “information edge.”
There is just one problem: Information travels so quickly that this “information edge” doesn’t work. 75% of all actively managed mutual funds failed to outperform their benchmarks over the 10 years ending December 31, 2010.
Ah, I can hear someone saying, “If 75% of equity managers didn’t outperform their benchmark, that must mean that 25% did!” You are right. Statistically, market participants have a 25% chance of being in the top quartile.
Unfortunately, just because a manager edged out the market in the last 10 years, they have no greater chance of maintaining that competitive advantage for the next 10 years. It turns out that past performance is not an indicator of future performance. While a particular manager may have been in the top quartile in the past, they have no greater chance of being the in top quartile in the future.
Isn’t it interesting that all investment prospectuses are required by law to contain the words: “Past performance is no indication of future performance.” Do you know why? Because it’s true. If beating the market were a matter of skill rather than luck, there would be more managers beating the market. Add to that the higher costs associated with active management, and active managers have an uphill battle to overcome their higher management fees, which they use to cover the cost of research and the turnover of securities.
The evidence is clear that active management is a risky investment choice that often disappoints investors. Alternatively, passive index investing involves no forecasting, stock picking or market timing. Passive managers seek to capture the returns of the market either by using low-cost index funds or institutional asset-class funds.
For more insight, listen to Jentner Wealth Management’s weekly podcast by clicking here. Or download Jentner’s newest white papers on The Four Cornerstones of Prudent Investing and The Active Versus Passive Investing Debate.
