Why Mutual Funds are better than Index Funds

[DesertCat]

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First, I don't think you have read all the posts. Second I have provided examples of mutual funds that have soundly beat their respective index over a reasonable period of time. Third, Berkshire Hathaway despite its anchor has continued to cream the market, especially when the market turns ugly.

I agree that a smart investor will develop their own portfolio to beat the indexes, mutual funds and Berkshire Hathaway. But if you have invested in the major indexes like the S&P 500 (not the specialty ones discussed in a different post) thinking they are better than the two alternatives, you are an incompetent investor.

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I have read all the posts, amd you have provided only ONE example of a fund that's beaten an index. Whether that fund is well run or just lucky, it's probably not going to beat the indexes in the future over long periods of time.

I described for you in general the handicaps mutual funds have. There are many, many very skilled, very good investors running mutual funds. And 95% of them will trail index funds over long periods of time. It's mainly because of the poor structure aand high costs of mutual funds. In fact, most mutual funds beat the indexes, BEFORE FEES. It's mainly the high fees that cause actively managed funds to trail index funds.

And to repeat. Berkshire Hathaway is NOT a mutual fund. It has no annual fees. It can invest where-ever Buffett wants in what-ever he chooses. That's exactly why it has outperformed. If it was a mutual fund, he would be hard pressed to beat indexes as well.

And lastly, the vast majority of people are "incompetent investors". That's okay, most people spend their time becoming good at something else, usually their careers. They simply don't have the time, education, and patience to invest successfully in the stock market. That's why Warren Buffett recommends they buy index funds.

You seem to think you understand investing well, but you don't understand the basic handicaps your managed fund manager will be suffering from. I think that makes you a good candidate for an index fund.

[Peter666]

How much money does Berkshire Hathaway hold in indexes? If Warren Buffet puts his money where his mouth is, then there is good reason to invest there. But the smart investor will follow his actions before acting on his advice.

Also, nobody said that Berkshire Hathaway is a mutual fund, and if you follow the link provided before, you will see a number of mutual funds trouncing the index thanks to the talent of one manager. The talented managers also realize the inherent weaknesses of a mutual fund, and take that into consideration in their plans. They are not incompetent.

So the bottom line is: follow the example of the proven managers. Invest like they do. But if you don't have the time or the inclination to do that, then pay them to invest your money for you. Do this so long as the net return after fees does better than the index over a reasonable period of time, or at least gives you peace of mind due to less fluctuation.

[Sniper]

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How much money does Berkshire Hathaway hold in indexes? If Warren Buffet puts his money where his mouth is, then there is good reason to invest there. But the smart investor will follow his actions before acting on his advice.

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Kinda hard for the small investor to buy out a collection of family owned business [img]/images/graemlins/wink.gif[/img]

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if you follow the link provided before, you will see a number of mutual funds trouncing the index thanks to the talent of one manager.

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I followed your link to CI Investments... first, their funds are only available to canadians. Second, a quick review of their fund performance list, did not show anything that outstanding. Third, for funds primarily invested in canadian stocks, the S&P500 wouldn't be the appropriate benchmark.

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So the bottom line is: follow the example of the proven managers. Invest like they do. But if you don't have the time or the inclination to do that, then pay them to invest your money for you. Do this so long as the net return after fees does better than the index over a reasonable period of time, or at least gives you peace of mind due to less fluctuation.

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You continue to disregard the fact that many people do not care to invest the time required to find the best funds/managers. Also, alot of research has demonstrated that the funds that perform best in any one year, and thus get the most cash inflows due to heavy advertsing of their performance, tend to underperform after that.

Bottom line: many people aren't willing to put in the time required to adequately make good decisions about their investments, and thus low fee index funds are a better investment than unresearched high fee mutual funds for those people.

[DesertCat]

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How much money does Berkshire Hathaway hold in indexes? If Warren Buffet puts his money where his mouth is, then there is good reason to invest there. But the smart investor will follow his actions before acting on his advice.

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I thought I was clear, but one more time. His advice is that if you can invest like Buffett (i.e. you understand value investing), do it yourself. If you can't, do index funds.

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Also, nobody said that Berkshire Hathaway is a mutual fund, and if you follow the link provided before, you will see a number of mutual funds trouncing the index thanks to the talent of one manager. The talented managers also realize the inherent weaknesses of a mutual fund, and take that into consideration in their plans. They are not incompetent.

So the bottom line is: follow the example of the proven managers. Invest like they do. But if you don't have the time or the inclination to do that, then pay them to invest your money for you. Do this so long as the net return after fees does better than the index over a reasonable period of time, or at least gives you peace of mind due to less fluctuation.

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Thanks for the great examples. All of the Mutual Funds listed in your link have lifetime returns below 10%, i.e. between 7 and 9.8%. The CI Canadian fund has a lifetime return of 8.9%. Vanguard's 500 index fund has a 9.87% ten year return, and a thirty year return of 12.12%.

The CI Canadian manager, Kim Shannon has done a bit better than that over the last ten years (13.3%), but the question is, was she just lucky, or good? Lucky means she had a style that worked well for a few years and pumped up her results. Clearly her last two years have done that for her (20%), in fact they may be the only reasons her ten year performance is above water.

Buying "hot funds" is a recipe for disaster. You buy internet funds after they post 100% gains, just in time to participate in in multiyear 50% losses. You buy momementum funds because they outperformed for three years, just when momentum dies, and they get killed.

If you are convinced that Shannon is actually good, will she stay good? I.e. will the fund grow too large and kill her ability to beat the indexes? What if she quits or retires, or just loses her work ethic? You don't have these risks with index funds.

And if you are right, and she's a great manager who will beat the indexes over time, then she's clearly an exception. 95% of the managers don't, and it's very difficult to weed out the many managers who've had a lucky few years, from the few who will be good for a long periods. So the best advice is, buy index funds.

[Peter666]

I acknowledge your point about ignorant investors. Although I don't see how it is more difficult to read a guide about the top performing mutual funds, then it is to study and understand what an index fund is.

Take it from the perspective of a financial planner: a couple totally ignorant about investing comes into your office asking for the best place to put their money. Would you put them into an index fund or a proven mutual fund? I would put them into a good value mutual fund because I think they would freak out if they saw the volatility in the index. This is due to their ignorance about markets, or just their nature. The longer they keep their money in, the more they will make, and thus the index funds are not conducive for them to keep peace of mind and to keep their money in place. So, that is why I argue that the mutual fund is still better than the index for the ignorant investor.

As for the CI funds, I will provide an explanation below.

[Peter666]

Relative to the Canadian market, the performance of those funds is good. The CI Investment fund has been around since the 1930's. But that was not the point of posting those examples.

The real point was to show how Kim Shannon has improved every one of the funds that she has entered as a new manager. Her record is stellar. She has managed some funds for over 10 years and some for less than five. But whenever she enters one, you see an improvement in the performance. The reason she would enter one to begin with is because it usually was not a good performer. One should judge a fund by its current manager, not previous managers and their respective performance.

Will she stay good?

Well, is there a reason she won't? (Other than outgrowing the market which was discussed earlier)
She uses a pretty simple mathematical system of value investing a la Benjamin Graham. Is anyone going to argue this is not a good way to invest?

Yes, she could keel over of a heart attack, lose her mind, or join the Communist party, but I hope those above her would do something to fix the situation. There are more managers than Kim Shannon, and I am sure they are learning from her.

Above average human intelligence will always beat the mediocrity of the index.

[gvibes]

disclaimer - I didn't read the posts in detail - some things may already have been said.

First, Berkshire Hathaway isn't a mutual fund - I don't know why it is being discussed.

Second, concerning the following statement:
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... Would you put them into an index fund or a proven mutual fund? I would put them into a good value mutual fund because I think they would freak out if they saw the volatility in the index...

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This is incorrect. Have you heard of "beta"? For instance, Legg Mason Value Trust (as far as I know, the only fund to beat the S&P 500 for each of the last 15 years), has a beta of 1.36. So, the best fund out there is appreciably more volatile than the S&P 500.

So, anecdotally, there doesn't seem to be a whole lot correlation between volatility and returns.

EDIT: actually, if you want to the lowest beta, stick with stocks!!! For instance, brk-a has a beta of ~.14

[Sniper]

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I acknowledge your point about ignorant investors. Although I don't see how it is more difficult to read a guide about the top performing mutual funds, then it is to study and understand what an index fund is.

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Reading a list of top performing mutual funds and investing based on that has been proven to underperform the indexes over time.

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Take it from the perspective of a financial planner

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Most financial planners will put you into the funds that pay them the most commission... like non-RB poker affiliates [img]/images/graemlins/wink.gif[/img]

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I think they would freak out if they saw the volatility in the index

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Most funds are just as volatile as the indexes, if not more.

[Peter666]

Hi, I am aware of Beta and discussed this as fluctuation. The mutual funds I deal with have significantly less fluctuation than the index. I am beginning to wonder whether Canadians have been offered much better mutual funds, or if American fund managers are simply incompetent. But I guess that is another topic.

[Peter666]

Now, if Warren Buffet said that an intelligent person who used the value investing style could not only beat the index but also Berkshire Hathaway (and value inveting is inherently less subject to fluctuation than the normal index) than a good value minded fund manager should easily overcome the 2% or so MER and deliver good long term performance. The handicap of huge holdings is much less than BRK anyway. This type of fund should easily beat the index.

PS The financial planner can also get away with overcharging the clients too
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