Mutual Fund Performance….Not so Good

Many recent studies have shown that mutual funds, as a group, perform worse than the market over the long-term.  A landmark 2003 Dalbar/Lipper study of all U.S. equity mutual funds, between 1984 and 2002, found that the average equity mutual fund returned 9.3% annually, underperforming the 12.2% annual return of the S&P 500 by a whopping 2.9%.  But the really bad news is that the average mutual fund investor realized an annual return of only 2.7%:

Annual Returns, 1984-2002	Cumulative Returns, 1984-2002
Sources:  Lipper, Vanguard, Dalbar

Let’s start with the first of these two bombshells.  Are mutual fund managers bad stockpickers?  No.  Given that mutual funds now comprise 68% of stock ownership in the U.S., their aggregate returns (before costs to their investors) should basically match those of the market.  Instead, most of the 2.9% difference can be explained by expense ratios, other sales charges, trading costs, and holding cash. 

Probably the most shocking statistic in these studies is the difference between the returns of mutual funds and investors in those mutual funds.  Who’s to blame for this debacle?  Mostly the investors themselves.  When investors are deciding which mutual funds to buy, they typically look first (and sometimes only) at the funds’ performance numbers.  They believe that market-beating performance indicates a good fund manager, one who knows what he/she is doing.  While this can be true, outperformance usually is indicative of the manager’s style being popular in the market.  But nothing stays popular forever, and that style eventually goes from “en vogue” to “in the trash.”  Unfortunately, when investors are throwing money at hot fund managers, that’s usually the time their style is peaking.  Mutual fund companies haven’t exactly discouraged this behavior either.  Their advertising normally promotes their top performing funds, while ignoring their funds that have underperformed.

Other studies have produced similar disparities between market returns and investor returns.  A more stark calculation by Forbes (“Your Own Worst Enemy,” 12/22/03) showed that, from 1993 to 2003, $1.02001 trillion was “lost” by mutual fund investors, relative to the S&P 500.  Of that, Forbes attributed it to:

    $0.00001 trillion ($10 million) from scandals in the mutual fund industry,

    $0.02 trillion ($20 billion) from high fees charged by mutual funds, and

 + $1 trillion from “stupid timing” (their words, not ours).

 = $1.02001 trillion

Suffice it to say, Monarch’s goal is for our stocks to outperform the S&P 500 in the long term.  We keep our fees reasonable, we minimize trading costs, and we don’t follow herd mentality into “hot” sectors.