Unrealistic investment expectationsArticle added by Lew Nason RFC, LUTCF on September 20, 2011
Lew Nason

Lew Nason RFC, LUTCF

Dallas, GA

Joined: October 13, 2006

My Company

You may not want to read the following information about investing in mutual funds (or the market in general) if you are counting on those reportedly high investment returns to help you make up for lost time in saving for your retirement.

Unfortunately, the financial media has duped us into believing that we can get rich overnight, which just isn’t so. But — even worse — people are putting their family’s financial future at serious risk by following the media’s advice.

There are many independent studies that clearly demonstrate the majority of mutual funds investors have investment returns considerably below what they were told to expect. This lack of investment performance is something Wall Street, brokers and your investment advisors don’t want you to know about.

If you want proof, here are just a few pieces of articles written over the last few years by highly credentialed and respected firms and authors. Also, included is my attempt to summarize these articles and put mutual fund investing into its proper perspective.

Mutual funds don't work for the majority of investors

The Quantitative Analysis of Investor Behavior Report examines real investor returns from equity, fixed income and money market mutual funds from Jan. 1984 through Dec. 2000. The study was originally conducted by DALBAR, Inc. in 1994 and was the first to investigate how mutual fund investors' behavior affects the returns they actually earn.

The following annualized returns for investors, whose average fund retention was 2.6 years in 2000 (down from 2.8 in 1999, but up from 1.7 after the stock-market crash in 1987), compared to corresponding indexes, illustrate the benefit of buy-and-hold strategies:
  • The average fixed-income investor realized an annualized return of 6.08 percent, compared to 11.83 percent for the long-term Government Bond Index;

  • The average equity-fund investor realized an annualized return of 5.32 percent, compared to 16.29 percent for the S&P 500 Index; and,

  • The average money-market fund investor realized an annualized return of 2.29 percent, compared to 5.82 percent for Treasury bills and 3.23 percent for inflation. Money-market fund investors lose money after inflation.
And, that is just the beginning of the truth about investing in mutual funds.
“The Lipper Survey of Mutual Funds reports that an astounding 98 percent of equity mutual funds have failed to keep pace with the S&P 500 Index…”

“Are Mutual Fund Managers Really This Bad?” Robert Zuccaro CFA, 1998

“According to John Bogle, former CEO of Vanguard Funds, one of the most trusted authorities on investing in mutual funds and a strong advocate for ordinary investors, such investors typically get poor returns on their investments. How poor? Between 1984 and 2002, the average stock fund investor made just 2.7 percent per year on their fund investments! Hard to believe isn't it? Yet this is for a period during which the S&P Stock 500 Index returned 12.2 percent, a -9.5 percent shortfall!”

“The Nasty Truth About Mutual Funds Investing,” Tom Madell, Ph.D., Mutual Fund Trends/Research Newsletter

Startling facts:
  • As of the 1st quarter of 1999, there were over 3,000 stock mutual funds for investors to choose from. Out of those 3,000+ funds, only 414 of those funds had a performance history of 15 years or longer.

    Only 17 (or 4 percent) of the 414 stock funds that had a 15-year performance history beat the market S&P 500 Index by at least 1 percent.

    And that was during one of the best times in history for the stock market and mutual funds. Remember the stock market lost over 40 percent from 2000 to 2003, and then lost over 50 percent from 2007 to 2009.

  • “Over the last 15 years, 85 percent of all mutual fund managers have failed to outperform the S&P 500 Stock Index,” John Bogle, Asset Management magazine, Jan.-Feb. 1997

  • Your broker might tell you that each year approximately 15 percent of the actively managed stock funds out-perform their respective indices. Unfortunately, what the broker isn’t telling you is the 15 percent of funds that beat the S&P 500 Index last year aren’t necessarily the same 15 percent that beat the index in prior years.

    This inconsistency is what makes it so hard to select a good fund -- last year's biggest winner may well be this year's biggest dog.

  • “39.4 percent of 614 aggressive growth funds crashed between 1962 & 1995 … if you had chosen your funds from among each year’s stars, you would have bought lots of funds that expired,” Jason Zweig, Money Magazine, Aug. 1997
In her article, “Was last year's rally a head-fake?”, Martha Brill said (my comments are in italics):
    “Jeremy Grantham says yes, and thinks the bear market will return in 2005. (Note: It actually didn't happen until 2007).

    In a stock market environment dominated by optimism, respected value investor Jeremy Grantham has spent the last few years sharing some sobering advice with investors: ‘Begin positioning portfolios defensively this year and prepare for a market plunge, which is part of a larger secular bear market, that will likely begin sometime in 2005.’

    ‘The sucker rally is still taking place, and has a good chance of continuing through the presidential election,’ says the 65-yearold Grantham, chairman and chief investment strategist at Boston-based institutional money manager Grantham, Mayo, Van Otterloo & Co. ‘But after that, I anticipate the Standard & Poor's 500 Index will fall below 775.’ (It fell to 735 in February of 2009).

    The problem now is that stocks, particularly those in the United States, are very expensive by historic standards. ‘Today, we have substantially the worst prospects for long-term global investment returns of my 35-year career when all asset classes are considered, particularly for U.S.-centric investors,’ he says. ‘Collectively, asset classes are simply the most overpriced they have ever been.’"
I believe it may be worse than that

In the past 80 years, we had two cycles of exceptional growth in the stock market, The Roaring Twenties and The Great Bull Run from 1949 to 1955. Both of these cycles were followed by long periods of slow growth.
  • The S&P 500 had an average annual return of 5.07 percent from 1932 to 1948. (16 years of exceptionally slow growth)

  • The S&P 500 had an average annual return of 4.08 percent from 1955 to 1970. (15 years of exceptionally slow growth)
Please note, I did not include the four years from 1929 to 1932 where the stock market crashed and the S&P 500 Index went from 24.35 to 6.89; an average loss of 27.07 percent annually.
What does all that mean?

First, consider that the S&P 500 Index reached a high point of 1,517 in Aug. 2000 and then dropped to a low of 841 in February of 2003 — a loss of 44 percent. The S&P 500 Index didn't get back to over 1500 until April 2007. Then it went down to a low of 735 in Feb. 2009 — a loss of 52 percent.

If the market drops 50 percent, it then has to have a total return of 100 percent to get back to its previous high point: i.e., if you have $100,000 and you lose 50 percent, then you’re down to $50,000. To get back to a $100,000 you need a 100 percent return on that $50,000.

If you lose 50 percent and it takes 15 years to get back to its original high point, then that’s only a 4.8 percent average annual return over that entire period.

The moral of this story: No one can accurately and consistently predict stock movement and so it doesn't make sense to pay fees to someone who's just guessing like everyone else.

According to the folks at the Motley Fool, only 10 of the 10,000 actively managed mutual funds available in 2007 managed to beat the S&P 500 consistently over the course of the past 10 years. History tells us very few, if any, of these funds will manage the same feat in the decade to come. What's your chance of picking one of those 10 funds, out of the 10,000 funds available?

I highly recommend you read “The Trouble With Mutual Funds,” by Richard Rutner, because all the above is just the beginning of the real story. You’ll learn:
  • There is really no such thing as a no load mutual fund …

  • Because you are paying fees to your broker every year whether your mutual fund makes you money or loses you money (It’s really a load).

  • And, the list of troubles goes on and on.
It’s truly a story that Wall Street doesn't want you to find out. Consider: If you do want to invest in mutual funds, and 98 percent of all equity mutual funds have failed to keep pace with the S&P 500 Index, then wouldn’t it make sense to look at the mutual funds that mirror the S&P 500 Stock Market Index?

Based on the above, it would appear that if you should decide to put your money into an indexed mutual fund, then you should be prepared to leave it there long term.

Also, note that mutual funds that mirror a stock market index generally have the lowest annual fees, the least amount of portfolio turnover and least amount of annual income tax consequences. Long-term, indexed mutual funds should outperform the vast majority of equity mutual funds.
The tortoise vs. the hare

Equity investments such as stocks or mutual funds frequently have flashes of brilliance, but occasionally fall back. Most investors would be pleased with gains in four out of every five years. But, do the great years offset those years with a poor or a negative return?

This is the question frequently asked by persons trying to contrast the level of performance with CDs, stocks, bonds, mutual funds, fixed annuities, variable annuities and other investments.

If you started with a $100,000 deposit, which strategy would produce a higher cash balance in five years?

YearThe HareThe Tortoise
1 20% gain 8% gain
2 21% gain 8% gain
3 10% gain 8% gain
4 16% loss 8% gain
5 10% gain 8% gain

The answer is that both of these strategies would produce exactly the same result of $147,000. What does this tell us? Consistency out-produces flashes of brilliance.

This poses an important question: Where is the justification for taking the much higher risk associated with equity investments?

What if you could find an investment vehicle that would allow you to reap the upside potential of the stock market without the downside risks associated with the stock market? And, you could access your money income tax free? Now, how much better off would you be?

Messages from a legend

Many people consider Warren Buffet the greatest investor of all time, and he amassed his wealth solely through investing in stocks. However, even with all the success, he still lives in the house he bought for $31,500 over 40 years ago.

Warren Buffet says, "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1."

"Someone's sitting in the shade today because someone planted a tree a long time ago."

"Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway."

MSN Money, “The Basics - Odds Say You Can’t Beat Index Funds,” Meir Statmen, 2002;
Investors Business Daily, “Why Is The S&P500 Index So Hard To Beat,” Dan Moreau, 10/1998;
Smart Money magazine, “The Reckoning,” Ken Brown, 1999;
The-Advisor.com, “Do Managed Funds Outperform The S&P 500?”, Oct. 2002;
Asset Management magazine, Ibbotson Associates, Kiplinger.com, Morningstar, Money Magazine, TDM Research, Iunits.com
Financial Advisor Magazine, “What Can We Expect From The Stock Market In The Coming Years?”, by Marsha Brill, Feb. 2004
“Are We Entering A Super-Bear Market Through 2014?”, www.megafoundation.org; and calculated from published S&P 500 returns.

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