This article appeared originally in the May 2011 Levitt Letter.
Two recent articles affirm that: 1) the SEC isn’t doing as much as it should to protect investors from stockbrokers, and 2) you can benefit by not hiring a financial manager. Complete editions of the articles below appear at www.levitt.com/news. Please see the collection of my Wise As A Serpent articles at www.levitt.com/essays.
Securities and Exchange Commission (SEC) Chairman Mary Schapiro said that budget constraints hamper the regulator’s ability to enforce the securities laws. She said the budget strain was forcing market analysts to use decades-old technology to “monitor trading that occurs at the speed of light.”
She also indicated the agency didn’t have the funds to hire market experts it needs to keep ahead of fraudsters and market manipulators. Ms. Schapiro painted a bleak picture of a resource-strapped agency trying to keep pace with securities markets that were growing larger and more complex.
The mutual fund industry keeps telling us that constant attention and skilled management is the key to our financial future. Too bad it isn’t true.
The upheaval of the last three years would have been ideal for those brilliant managers to demonstrate their magic. But they didn’t. A close look at how managed funds that invest in both stocks and bonds did compared to similar portfolios that you and I can build in our spare time showed that Home Brew rules. The results show, yet again, we can do well on our own, sim- ply by being lazy, thrifty, and diversified. When the time came for those attentive and well-paid managers to duck or dodge, they didn’t. More important, they did worse than passive, unchanging portfolios. Here’s how it happened.
Diversification. The Vanguard 500 Index fund’s annualized return over the last three years was a loss of 2.9% a year, even with dividend reinvestment. The Vanguard Balanced Index fund, a traditional 60/40 mix of domestic stocks and bonds, however, provided a return of 1.85% a year over the same period. The low-cost (0.25% a year) index fund also did better than 83% of its managed competitors.
Thrift. If you divide all 248 of the funds Morningstar calls “moderate allocation” into two piles, more expensive and less expensive, the less expensive half does better. Over the last three years, the funds with expense ratios under 1.12% returned an average annualized 1.18%. Funds in the more expensive pile returned only 0.06%.
The least expensive quarter of these funds, those with expense ratios under 0.89%, provided an annualized return of 1.18%. The most expensive quarter of all funds, those with expense ratios over 1.40%, provided an average return of minus 0.15%.
Year after year, the data show that high-cost management transfers money from your pocket to its pocket.