January 20, 2011
The Results Are In – Active vs. Passive
Most investors track the direction of the financial market by checking where the S&P 500 or Dow Jones Industrial Average finishes on a daily basis in their local paper.
Some days they were pleased with what they saw and others not, but as a whole 2010 left most investors optimistic about the direction of their retirement portfolios. However, most people forget to check how their portfolio returns did relative to these numbers, and if they had, might think of changing advisors as a New Year’s resolution as well.
In 2010, a mere 25% of active managers beat their respective benchmarks, with many active managers calling it the “toughest year on record.” High correlations between stocks, low spreads on returns, and tough economic times were their reasons for underperformance. Nowhere did they mention that either high costs or lack of ability could have played into their lacking returns. Better yet, only two-thirds of active managers plan to beat the S&P 500 next year, which leaves me wondering what the other third plan on getting paid for while going to work each day?
Upton Sinclair once said that “it’s amazing how difficult it is for a man to understand something if he’s paid a small fortune not to understand it,” and this seems to be the case with active management as well. The latest data from Standard and Poor’s shows that active managers continue to underperform and at a rate that is far worse than chance.
This underperformance by active managers is not unique to 2010, yet instead, it only gets worse when you look at it over the long run. For the five years ending September 2010, only 4.1% of large-cap funds, 3.8% of mid-cap funds, and 4.6% of small-cap funds maintained a top-half ranking over five consecutive 12-month periods. Statistically, 6.25% of funds would fit this criteria, assuming a 50% chance of falling into the top half each year.
This shows that not only have active managers underperformed their respective benchmarks in 2010, but that you have a better chance of picking which one will outperform its peers over a five-year period by blindly drawing a name from a hat!
So as you look back over 2010 and plan for another year, do yourself a favor and review your retirement portfolio. It’s more important than you might think and can make a drastic impact on the way you spend your retirement years. No individual wants to pay a premium for the likelihood of underperforming market returns, yet a majority of the populations does.
Take a moment this New Year and make sure you are not just following the crowd. Though, for current Rockbridge clients, you can cross this one off and move to the next thing on your list of resolutions!