Play to win

Wouldn’t it be nice to be fairly sure you were going to win every time you went out on the tennis court or hockey rink? Based on recently released performance stats, I guess Vanguard must know that feeling. Its funds had a good year in 2012, which has been the pattern for quite some time now. 

They make it look easy

Every year thousands of fund managers toil over decisions of what to buy and when to sell. Some get it right and some make a mess. In 2012, with all the major markets doing well, making a nice return should have been pretty easy. It clearly was for Vanguard, based on its results, summarized by this chart.

Click on image for full Vanguard report

For the year, 73 percent of Vanguard funds beat their Lipper group averages.  And if you look back 3, 5 or 10 years, the outperformance is even stronger at up to 90 percent of funds outperforming their asset classes. (See results in more detail)

Vanguard must have the best forecasters and stock pickers in the business, right? No, to the contrary.  As an index fund provider, Vanguard doesn’t pick stocks, it simply creates funds that track different kinds of stocks…and does the same with its bond funds too, with similar results.

The company’s biggest advantage is generally agreed to be its low management costs, consistently among the lowest in the business. With less of the pie going to management expenses, more return stays in the funds and flows through to shareholders.

I’ve singled out Vanguard because they reported their results so clearly and graphically, but I expect we’d see similar numbers for State Street and BlackRock, two other giant providers of index funds.

This is not meant as an endorsement for any specific fund or provider, but the numbers tell a strong story about the index approach. By simply seeking to match the performance of various asset classes, indexers have consistently beat group averages.

Yes, some active managers also beat the averages in any given year, but doing so year after year is very rare. And I’m not sure how anyone could accurately predict – before the fact – which active manager was going to outperform over a five- or ten-year period. There are no guarantees in investing, but in my view, sticking with well managed indexes provides the most reliable chance of beating benchmarks over the long term.

A first step only

Of course performance game is only one element of your long-term investment success. As we described in a previous article, we see index ETFs as great building blocks for low-cost, tax-efficient, diversified portfolios. When you build your portfolio with strong materials, you can then focus on your goals instead of being distracted by the active management performance derby.

John Osbon – josbon@osboncapital.com