Investing 101: Should You Hire Fund Managers?

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We live in a service-based economy. Over the past few decades, America’s service sector has grown to the point where you can hire someone to complete almost any task imaginable — from dog walking to video game testing. With that in mind, it only makes sense that you would pay a professional to manage something as important as your investments, but that’s not always the case.

Investors placing their money in actively managed funds with hopes of outperforming benchmarks may be sorely disappointed with their year-end statements. In 2013, only 50 percent of active stock-fund managers beat their respective benchmarks, while just 48 percent of fixed-income managers outperformed their respective measuring sticks, according to a new analysis from Vanguard using data provided by Morningstar. Investors looking for better odds than a coin flip needed to invest in emerging market funds, where 56 percent of managers beat their benchmarks.

One year certainly doesn’t make a trend, but actively managed funds are notorious for their lackluster performances. “In 2013, it was really difficult to determine, based on market conditions, whether active managers would do well or do poorly,” said Brian Wimmer, an investment analyst at Vanguard. “This result is consistent with our research showing that active outperformance is difficult to predict and that, on average, active funds have had regular periods of market-lagging returns.”

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There are a wide variety of challenges facing investors trying to pick a winning fund manager. Last year, an investor could have picked a domestic equity fund manager that beat the benchmark by 8.53 percent or one that lagged it by 8.55 percent. The range varies from 12.47 percent to negative 12.85 percent with emerging market fund managers, and 3.06 percent to negative 1.92 percent among fixed-income managers.

As the chart above shows, the long-term track record for active fund managers is not encouraging. Vanguard analyzed all actively managed U.S. equity funds that existed at the start of 1998. Out of 1,540 funds, only 55 percent survived after fifteen years and just 18 percent both survived and outperformed during the period. Furthermore, even if you do manage to pick one of the 275 outperforming funds, patience is needed to reap the rewards as 97 percent of the winners experienced at least five calendar years in which they lagged their relative benchmarks.

Vanguard believes that while finding talented active managers is a daunting task, investors can significantly improve their chances at success by simply focusing on fees — which happens to be Vanguard’s specialty. “We don’t view the active versus passive discussion as an either-or question,” Wimmer said. “Active and passive approaches can be effective as long as investors utilize low-cost funds and remain disciplined over time. High costs and performance-chasing drastically reduce the odds of investors’ achieving investment success.”

Even Warren Buffett, one of the best investors in history, is a fan of low-cost index funds. “My money, I should add, is where my mouth is,” Buffett said in his letter to shareholders this year. “What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit …. My advice to the trustee could not be more simple: Put 10 percent of the cash in short-term government bonds and 90 percent in a very low-cost S&P 500 index fund.”

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