Beating a donkey for not being a horse

Active investors are at it again
Underperforming, that is. According to the Wall Street Journal, 74 percent of actively managed large cap funds are lagging the S&P 500.   The Journal’s story, “Stock Pickers Have Tough Time in 2014” lists the usual reasons active managers underperform such as market timing, high costs, wrong guesses and overconfidence in forecasting. Even the weather gets blamed. Hedge funds – the turbo-charged market masters – are getting the worst of it, now into their sixth year of underperformance.

Wrong race
Why should you care about about “beating” the averages?  You shouldn’t, for two reasons.  First, “average” returns, that is, index-based returns, will beat almost any form of active management over time due to cost, taxes and the zero-sum nature of investing.  The evidence is really not in question on this. A recent Vanguard study found the average actively managed fund in 10 of 11 asset classes lagged its respective index benchmark over the last 15 years. See Passive Power for more on that subject.

And wrong question
Secondly, racing, betting, speculating or guessing with your money is a bad idea.  The active management industry does a real disservice to investors by urging them to gamble their portfolio on potentially getting some small excess return at the expense of some other investor who is also guessing.  Wrong.  The real question to be addressed is not how to find the next big winner, but instead: “what are my goals and how can I get there with the least risk necessary?”

I say don’t blame actively managed funds for lagging the indexes.  Costs put them at an inherent disadvantage. They’re high priced donkeys in a horse race. But I do blame advisors for promoting them as appropriate.

Now is the time
As we pass the mid-year it is the perfect time to make sure you are on track with your portfolio by asking smart questions. Stay tuned for upcoming Osbon articles “5 Investment Things to Do This Summer,” and “6 Questions to Ask Your Investment Advisor.”

John Osbon – josbon@osboncapital.com