Picking the Right Horse

Every year, financial magazines and newspapers come out with a “Best Mutual Funds” issue. They pick which ones have the best 1, 5, and 10 year track records. They print flattering reports on the fund managers and their philosophies. For once, then, I was surprised to see Fortune magazine, in December 2009, went back and analyzed what percentage of actively managed funds actually beat their assigned index. In other words, what percentage of the time would investors have been better off by just buying an index fund instead of picking one of those profiled in the magazines? A recap of the results, compiled by S&P:

For Large Cap (index is S&P 500): 37%
For Small Cap (index is S&P Small Cap 600): 32%
For Foreign Stock (index is S&P 700): 13%
For Int. Term Bonds (index is Barclays Interm Gov/Credit): 20%

In other words, somewhere between 13% and 37% of managers accomplish the mission of beating their assigned index. This data was compiled over a 5-year period. Academic studies that look at rolling 5-year periods find that the managers who fit in that 13% – 37% category changes. In other words, for a particular 5-year period, most managers who “rise to the top,” were at the bottom in some 5-year period prior to that point. So, the trick then becomes, picking the right “horse,” at the right time, and staying on it for exactly the right ride. For more information and data on how difficult this can be, see Stuart Lucas’s book on “Wealth,” or Burton Malkiel’s “Random Walk Down Wall Street.”

Holly Donaldson

Holly P. Donaldson, CFP® writes and consults on the psychology of money. Her fee-only, product-free financial planning practice focuses on increasing financial self-efficacy for those seeking a financial navigator to help them make good decisions. She is the author of The Mindful Money Mentality: How to Find Balance in Your Financial Future (Porchview Publishing, 2013) and publisher of the award-winning monthly e-letter, "The View From the Porch." With a fully virtual practice in Seminole, Florida, she primarily serves clients located in the Tampa, St. Petersburg, and Clearwater areas. Holly will also work with clients who are a good fit located elsewhere in the United States.

Leave a Reply