Active Investors Lose - Show 125

Thursday, May 22, 2014 5,664 views

Active investors lose. They lose consistently. If one were to describe their analytical techniques, it could be summed up in one word: Speculative. Too often, they attempt to predict the future movements of the stock market based on too little information. But how bad are they losing?

A study conducted by Indiana University Professor of Finance Charles Trzcinka shows the difference between the annualized returns of the average mutual fund (time-weighted returns) and those of the average mutual fund investor (dollar-weighted returns). The average active fund complied a 5.7% time-weighted, annualized return from 1998 to 2001. The average fund investor, however, only earned paltry 1.0% annualized return. Active investors also pay higher expenses, taxes and fees. When taxes and inflation are considered, we estimate the average mutual fund investor lost a 3.3% annualized return over the 4-year period. If only the bad news stopped there.

In a 2013 Dalbar study, a comparison of the returns of an average equity fund investor to the returns of the market from 1993 through 2012 shows the average equity fund investor earned returns of only 4.25%, while the S&P 500 returned 8.22%. To take it a step further, an IFA all-equity portfolio managed to return over 10%.

Active management seeks to beat the market. Index fund investing simply tries to capture the market. So why accept those returns as opposed to trying to beat them? As you saw earlier, an active investment style starts off in the red because of all the extra fees and taxes that come with a high turnover. So not only do you have to beat the index, you have to beat it handily.

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