Finding an ETF or mutual fund that can consistently beat the market year in and year out is practically impossible.
That’s not for lack of options. Wall Street is full of sharp minds that are often willing to share their investment insights and strategies with everyday investors through a mutual fund. In exchange, they ask for a small percentage of the assets you invest with them.
Unfortunately, despite their best efforts, most fund managers don’t provide enough returns to investors to make up for their fees. And those that do are hard to identify in the moment and rarely beat their peers consistently year after year.
But one ETF has a strong track record of returns. It consistently performs in the top half of all funds; over the long run, it’s better than almost all of them. It beat 88 of large-cap mutual funds over the past 10 years. And there’s good reason to expect it to remain consistently better than nearly every fund out there.
The ETF that consistently outperforms nearly 88% of mutual funds is the Vanguard S&P 500 ETF (NYSEMKT: VOO).
Why it’s so hard for fund managers to outperform the S&P 500
S&P Global publishes its SPIVA (S&P Indices Versus Active) scorecard twice a year. The scorecard compares the performance of active funds to the S&P indexes over periods of one, three, five, 10, and 15 years. Most active funds don’t have a great track record:
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Over a one-year period, nearly 60% of actively managed large-cap mutual funds underperformed the S&P 500 after accounting for fees.
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Over three-year and five-year periods, the percentages of underperforming active funds rose to 79% to 80%.
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Over 10 and 15 years, between 87% and 88% of active funds underperformed.
There are two big challenges facing active large-cap fund managers.
First, it’s important to consider how the stock market works. For every share someone buys of a stock, someone must be willing to sell that stock. The vast majority of stock trades, about 90%, come from big institutional investors. These are the smartest minds on Wall Street. But, by the nature of the market, they can’t all be right. And since they account for essentially all of the market, that means only about 50% of institutional investors will beat the average.
In other words, the market for large-cap stocks is very efficient with prices reflecting true market values and all knowable information. It’s practically impossible for fund managers, as a group, to have a meaningful advantage over the average Joe.
But they don’t just have to outperform the S&P 500 or the average Joe. They have to outperform by enough to justify their fees. And that’s the second challenge facing fund managers. That pushes the odds of outperformance way down, and it’s reflected in the table above.
Jack Bogle and Warren Buffett have a big warning about the impact of fees
The impact of fees on investors isn’t a new phenomenon. In fact, fees have come down in recent years as it becomes easier for investors to access investments and information.
Jack Bogle started the Vanguard Group and the first-ever index fund because he saw how fees impact the performance of the average investors. In a 1997 paper, he wrote, “Investors as a group must underperform the market, because the cost of participation — largely operating expenses, advisory fees, and portfolio transaction costs — constitute a direct deduction from the market’s return.”
Warren Buffett similarly warned against fees repeatedly in his letters to Berkshire Hathaway shareholders. In 2017, he noted many of his friends of modest means heed his advice and invest in an S&P 500 index fund. The wealthy elite, however, look to beat the market returns. “My calculation, admittedly very rough, is that the search by the elite for superior investment advice has caused it, in aggregate, to waste more than $100 billion over the past decade,” he wrote to shareholders.
Buffett notes there are fund managers that can outperform the S&P 500, but in aggregate, he believes his estimate is conservative. Importantly, identifying one of those fund managers capable of outperforming before they outperform the market is practically impossible. You can never know if a manager has some immense skill enabling them to outperform their fees or if they’ve just been lucky for a few years.
Therefore, the best option is to invest in an S&P 500 index fund. It’ll come close to matching the market returns with the smallest fees possible.
What to look for in an index fund
There are only a couple of factors to consider when selecting an index fund to lower your costs as an investor:
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Expense ratio: This is the percentage of assets under management you’ll pay to the fund manager. The Vanguard S&P 500 ETF has an expense ratio of just 0.03%, one of the lowest in the industry. That means you’ll pay just $3 for every $10,000 you invest.
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Tracking error: Tracking error tells you how consistently close (or wide) the ETF tracks the index it’s meant to. If your fund has a high tracking error, your returns might not match the market exactly as the ETF moves well above or below the actual index value. If you want to match the market returns, look for an ETF with a low tracking error. The Vanguard S&P 500 ETF has a tracking error of about 0.02%. Again, one of the best in the industry.
If you can keep your fees low, you’ll outperform almost every active mutual fund in the market. And that’s exactly what you can do with the Vanguard S&P 500 ETF.
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This ETF Has Consistently Outperformed 88% of Mutual Funds Over the Past Decade was originally published by The Motley Fool
Source: finance.yahoo.com