This investment has outperformed almost every Wall Street pro over the last 15 years, and it's quite simple.
Professional fund managers get paid a lot of money to take charge of billions of dollars in assets for investors. They tend to have a certain level of education and expertise, which should give them a leg up on the average Joe investing at home. Unfortunately, most professionals aren't worth the price.
Anyone can outperform 92% of active fund managers over the long run, and they don't need any special insights into the market to do so. In fact, the necessary approach is about as hands-off as it gets.
All you need to do is buy an S&P 500 index fund, such as the Vanguard S&P 500 ETF (VOO 0.87%), and hold it forever.
92% of active large-cap fund managers underperform
S&P Global publishes its SPIVA (S&P Indices Versus Active) scorecards twice a year, comparing the performance of active funds and the S&P indexes over various periods. It found 92% of active large-cap fund managers underperformed the S&P 500 over the last 15 years as of the end of June. Even over the past year, less than 40% could outperform.
What's going on here?
Consider that the stock market is largely controlled by institutional investors. On any given day, over 80% of the volume traded in large-cap stocks comes from big institutions moving money around. In other words, the market price is dictated by institutional investors.
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These super-smart, highly experienced fund managers are operating in a very efficient market because they're working against other super-smart, highly experienced fund managers. That completely wipes out their advantage over the average Joe investor, leaving their odds of outperforming the market somewhere around 50/50.
But they don't just have to outperform the market. They have to outperform by enough to justify their fee. And they have to do it year after year. That's a lot to ask.
Jack Bogle and Warren Buffett explain why active fund managers cannot outperform the market
In a 1997 paper, Vanguard founder Jack Bogle noted a simple reality of investing in the stock market: "Investors as a group must underperform the market, because the costs of participation -- largely operating expenses, advisory fees, and portfolio transaction costs -- constitute a direct deduction from the market's return."
Warren Buffett referred to the same market forces in his parable of the Gotrocks, who lost their fortune to "helpers" like brokers, managers, and financial advisors. He sums up the parable with this simple idea: "For investors as a whole, returns decrease as motion increases."
By and large, active fund managers trade a lot more than an index fund. They create a lot more "motion."
The fund manager who can consistently outperform the market by more than their fees for an extended period of time is rare, but they do exist. But even if you find one, you can't know for certain until after they've actually outperformed the market. Even then, the decision to continue investing with the fund manager requires you to determine whether the results came from skill or luck. That means picking the right fund and fund manager is a very difficult task.
Therefore, the fund option with the highest expected return over the long run is going to be an index fund. You'll outperform 92% of active fund managers. That's because index funds offer the lowest cost of participation, the core factor dragging down returns, as Bogle put it.
What to look for in an index fund
There are two main factors that you need to consider when buying an index fund in order to lower your "costs of participation":
- Expense ratio: This one is straightforward. It's the percentage of assets you'll pay to the fund manager to manage the portfolio. Some index funds have extremely low expense ratios of just a few basis points. The Vanguard S&P 500 ETF, for example, has an expense ratio of just 0.03%. That means you'll pay $3 for every $10,000 you invest in the fund.
- Tracking error: Tracking error is an oft-overlooked measure of index ETFs. Tracking error tells you how consistently close (or wide) the ETF tracks the index it's benchmarked to. If your fund has a high tracking error and low expense ratio, it could end up costing more than an ETF with a very low tracking error and high expense ratio. That's because investor returns won't match the index as closely, which increases the risk of underperforming the index based on when you buy or sell.
There are plenty of great index funds out there, and the odds are very good that buying one is a better choice than buying an actively-managed mutual fund.
Adam Levy has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends S&P Global and Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
FAQs
Therefore, the fund option with the highest expected return over the long run is going to be an index fund. You'll outperform 92% of active fund managers. That's because index funds offer the lowest cost of participation, the core factor dragging down returns, as Bogle put it.
What is an investment where a professional manager puts together money from many investors and buys many different stocks and bonds? ›
A mutual fund is a company that pools money from many investors and invests the money in securities such as stocks, bonds, and short-term debt. The combined holdings of the mutual fund are known as its portfolio. Investors buy shares in mutual funds.
Do most actively managed funds outperform the market? ›
In general, actively managed funds have failed to survive and beat their benchmarks, especially over longer time horizons. Just one out of every four active funds topped the average of passive rivals over the 10-year period ended June 2023.
What percent of professionals investing in large companies beat the market? ›
Question: Over a recent 20 year period, what percent of pros investing in large companies "beat the market? Answer: 94% of investment pros underperformed (see below), so 6% outperformed.
What percentage do investment managers take? ›
The management fee varies but usually ranges anywhere from 0.20% to 2.00%, depending on factors such as management style and size of the investment. Investment firms that are more passive with their investments generally charge a lower fee relative to those that manage their investments more actively.
What type of investment generates constant income? ›
Real estate is a very popular and a highly attractive investment option, especially for an income-investing portfolio. Real estate investments can generate a constant stream of income in the form of rental income. It also offers prosperous long-term capital stock growth options, in addition to certain tax benefits.
Which one of these investment pools the money from many investors hires a professional money manager to manage those funds and offers diversification to investors? ›
Mutual funds pool the money of many investors to purchase a range of securities to meet specified objectives, such as growth, income or both. Mutual funds can offer cost-effective diversification. Each mutual fund has a different investment objective. Some funds invest in a particular product, such as stocks or bonds.
Does anything beat the S&P 500? ›
The index includes value stocks and growth stocks from all 11 market sectors, as defined by the Global Industry Classification Standard (GICS), and it covers about 80% of the domestic equities market. Somewhat surprisingly, only one GICS market sector outperformed the S&P 500 over the last five years.
What percentage of fund managers outperform? ›
The SPIVA scorecard found that just 40% of large-cap fund managers outperformed the S&P 500 in 2023 once you factor in fees. So if the odds of outperforming fall to 40-60 for a single year, you can see how the odds of beating the index consistently over the long run could go way down.
Do financial advisors beat the S&P 500? ›
Less than 10% of active large-cap fund managers have outperformed the S&P 500 over the last 15 years. The biggest drag on investment returns is unavoidable, but you can minimize it if you're smart. Here's what to look for when choosing a simple investment that can beat the Wall Street pros.
Household names like Peter Lynch and Warren Buffett achieved their successes by picking individual stocks. Many individuals you've never heard of have attempted similar strategies and failed. Even most professional mutual fund managers can't beat the market.
Do 90% of investors lose money? ›
90% Retail Investors Lose Money - Rediff.com. Only the top 5 per cent profit makers account for 75 per cent of profits.
What is the highest salary for an investment manager? ›
What is the highest salary for a Investment Manager in India? Highest salary that a Investment Manager can earn is ₹35.0 Lakhs per year (₹2.9L per month).
Can portfolio managers make millions? ›
Compensation spans a huge range at this level because it's linked almost 100% to performance. We gave a range of $500K to $3 million USD in the hedge fund career path article for the “average” PM, with median pay in the high-six-figure-to-low-seven-figure range.
What is the average AUM for a financial advisor? ›
For an investment amount of $500,000, the average advisor fee was 1.05%, or $5,250. From 2013 to 2016, the median assets under management (AUM) grew 6% from $86 million to $92 million. If this trend continues, by 2021, the median AUM for financial advisors will hover around $97 million.
What is a type of investment that invests in a lot of different companies called? ›
A mutual fund is a pool of many investors' money that is invested broadly in a number of companies. Mutual funds can be actively managed or passively managed.
What is a group of investments managed by a professional investor called? ›
Mutual fund: An investment vehicle that allows you to invest your money in a professionally-managed portfolio of assets that, depending on the specific fund, could contain a variety of stocks, bonds, or other investments.
What type of investment is a professionally managed fund that pools money from many different investors to purchase diversified holdings? ›
Mutual funds are investment vehicles that pool money from multiple investors to purchase a collection of securities, which are managed by a portfolio manager(s). You can buy shares of mutual funds at the net asset value (NAV) of the fund, which is determined at the close of each day.
What is the money that an investor makes on an investment called? ›
The primary way to gauge the success of an investment is to calculate the return on investment (ROI). ROI is measured as: ROI = (Current Value of Investment - Original Value of Investment) / Original Value of Investment. ROI allows different investments across different industries to be compared.
