Breakout

Fire Your Fund Manager: Stock Indices Trounce Portfolio Pros

Breakout

By any measure, 2013 looks set to be another great year for stocks. In fact, if the final three weeks go well, it could the best 12-month jaunt for the large cap benchmark index (^GSPC, SPY) since a 31% gain in 1997.

While those kind of profits are sure to delight most investors, the truth is many people simply won’t get them. In fact, studies show that up 75% of professional money managers lag their benchmarks over time simply because they actively try to beat them. As odd as it sounds, had they done nothing they’d probably have been better off.

“It’s not unusual for indexes to outperform the managers consistently over time,” says Hugh Johnson of Hugh Johnson Advisors in the attached video. “You’re not going to find from me an argument against indexing, by both professional or large investors, as well as small investors.”

And he’s not alone. The indexing trend has been growing and gaining converts since 1975, including such big names as Berkshire Hathaway billionaire Warren Buffett.

As Johnson points out, the risk of losing to an index goes up almost as fast as the market does. “Large cap managers in particular have a lot of trouble beating the index in a rising environment.”

That said, in his own practice, Johnson says he uses what he likes to call “a mid-step approach” by building portfolios that use indexes but then superimpose an asset allocation strategy on top of it.  By that he means, tweaking the natural mix of sectors, rather than simply putting it all in one index fund.

“What that does is help you in a declining market environment, but not so much in a rising market,” he says.

Of course, deciding when to actually fire your portfolio manager is not so easy. Individuals tend to buy a fund after it turns up on their radar for being hot, and then sell it when it inevitably has fallen out of favor and turned cold.

“Put up with [under-performance] for a while but don’t put up with it for too long,” Johnson says. “If you’ve consistently, over time, underperformed, don’t tolerate it.  Do something about it and buy an index."

 

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