Jim Cramer Cartoon

Cramer Weighs in on Mutual Funds

Jim Cramer Cartoon

As you may have guessed or perhaps already have known from articles such as this one or this one, we at Index Fund Advisors, Inc. are not fans of CNBC’s Jim Cramer. While some may claim that he has helped to educate his viewers who would otherwise know next to nothing, we maintain, based on studies such as here, that Cramer’s stock picks have provided no value to the investing public. It’s not a question of how smart Cramer is (we don’t doubt that he is a very smart guy), it’s just that in an efficient market where information is reflected in current prices, the talent (real or imagined) of one person is not a reliable source of alpha. As Kenneth French1 said, "The market is smarter than we are and no matter how smart we get, the market will always be smarter than we are."

Recently, as summarized in this CNBC article, Cramer voiced his opinions on mutual funds in general and indexing in particular. Surprisingly, we agreed with some of it such as when he said that actively managed mutual funds tend to underperform their benchmarks and then add insult to injury by charging some of the highest fees in the business. To summarize it in his terms, active mutual fund investors are getting hosed.  From there, he pivots to a reluctant recommendation of low-cost index funds based on the S&P 500 Index:

“At the end of the day, I think a cheap S&P 500 Index fund is the least bad way to passively manage your money—better than the vast bulk of actively managed funds.”

Naturally, his preference is for his viewers to have a collection of individual stocks that they trade based on “homework,” or as Cramer’s Rule #6 says, “as much as one hour per week per position.” A quick calculation suggests that a Cramer viewer with ten positions (on which he does five hours per week of homework—half of the maximum) totaling $100,000 who manages to achieve a respectable 2% alpha, the value of the homework is about $8 per hour! We acknowledge that some people may find the homework entertaining, and our answer to them is this.

For us, the S&P 500 is just the beginning of indexing. Most investors should further diversify it by minimally adding international market indexes. More knowledgeable (or professionally guided) investors can add small cap and value indexes from both the U.S. and around the world. Furthermore, most investors should have some exposure to fixed income for the purpose of controlling their overall risk and providing a source of liquidity if needed. To see what level of risk is right for you, please take IFA’s Risk Capacity Survey.

1Ken French, "Stock Price Best Value Guide, War or Not," Australian Financial Review (March 2003).