What is a managed mutual fund?
A managed mutual fund is one in which a decision-making process determines security selection. While index funds seek to mimic the returns of a particular index such as the Standard & Poor’s 500, a managed mutual fund sets different goals, like maximizing growth, generating high income or perhaps beating a specified index. The decisions can come from a single manager, a team or even a computer program.
There is nothing pernicious about the concept of having active fund management. The goals of most are usually sound. The managers and their staffs are likely very smart. Many no-load managed funds present appropriate diversification, logically structured portfolios and reasonable expense levels for the work being done. The problems with managed funds arise with market characteristics and human nature that have historically led to shareholder disappointment.
Why you should avoid managed mutual funds
Poor long-term results
Annually, about 65% of managed mutual funds underperform the indices they’re attempting to beat. Over 10-year spans, that percentage sits around 80%, and over 20-year spans it hits 90%. Since you invest for the long run, you face a managed fund universe in which only one in ten outpaces the relevant funds in the indexed universe. Moreover, there is no way to correctly guess which few funds will be the winners. Multiple surveys confirm the poor performance of managed money. Figure 29-1 highlights a few.
Over-hyped short-term results
You will never see a mutual fund advertise how poorly it did, but you can easily find plenty of ads for funds that did well recently. Because of this skewed information flow, many people mistakenly believe professional money managers know how to beat the market. They do not.
There are thousands of financial professionals and millions of amateurs who buy and sell stocks and bonds every day using all information available. Their combined activity renders efficient prices. Fund managers buy securities with future expectations no greater than anything you might randomly buy.
Tendency toward indexing
If you decide to pay more for managed money, you expect something better than an index. However, many managed mutual funds have grown so large they have become closet index funds. Most funds have restrictions on the percentage of assets they can put into any one company. Forced to spread assets in every direction, these funds have expected returns similar to an index, minus fees.
High fees
Many index funds charge annual fees of less than a tenth of a percent. Most managed funds charge much more; many have fees in the 1.5% to 2.5% range. These rates are as damaging as they are sad given the poor results.
What you should do instead
If you own or are considering a managed mutual fund to fulfill a specific investing need, seek an index fund that invests in the same category.
If your managed fund ownership represents your primary investment involvement, click here for a more effective regimen.