Every six months, Morningstar releases their “Active/Passive Barometer.” We feel Morningstar is a good source of data as they tend to be unbiased. While Vanguard or Dimensional Fund Advisors will always tell you passive is better, and active fund managers will always mine data that trumpets the benefits of active management, Morningstar is close to neutral.

Each day Morningstar runs articles giving positive reviews to active managers but also articles on the shift in the industry out of active management into passive funds. Investment managers who select funds pay to use their star system and see reviews of fund management in determining which active funds to select. We believe Morningstar is a good source of objective analysis (if anything would support active management) when it comes to analyzing active vs. passive performance.

As seen below, Morningstar’s research shows that paying for active management is a bad bet for investors. The following table notes what percent of active management has beaten comparable passive funds over a given time period. The data was compiled as of June 30, 2019.

The data is clear, active management has a low success rate. Of the 101 numbers in that chart, 82 of them are below 50%. It’s also important to note the longer the time period, in general the less likely it is for active management to outperform a passive fund.

There does seems to be one anomaly and one exception to the rule. The 10-Yr Foreign Small-Mid Blend number is very positive. Active managers in that space will say the market is less efficient so there is more opportunity for a manager to add value. Perhaps there is truth to that, but then it doesn’t explain the dismal performance over the last 1, 3, and 5 years. Looking through Morningstar’s data, this category is very small. Only 17 active funds and 7 passive funds were around 10-years ago (compared to 451 & 122 in US Large Blend). We’re dealing with a small sample size, five to ten years ago, and the passive funds likely were relatively poorly managed and expensive compared to what is available today.

The corporate bond space is an exception to the rule, though it can be explained. Overtime, more credit risk (higher yielding, riskier bonds) should outperform higher credit quality bonds. And with normal sloping yield curves, longer duration bonds should outperform shorter duration bonds. If you wanted to manage a corporate bond fund and outperform your index, or a passive fund tracking an index, you should tilt your holdings to higher-yielding, longer bonds. For the last 10 years, companies have fared well and interest rates have fallen, both helping the tilts of active bond managers. We see this manifest itself in the 3, 5, and 10-year performance. In the second half of 2018 when stocks did poorly active managers got beat handedly by passive funds as credit exposure was a negative. Going forward we expect active corporate bond managers to outperform, but they are taking on a different risk profile. As comprehensive financial planners, we aren’t interested just in your bond holdings, but rather the performance of your entire portfolio. We look to manage the duration of a bond portfolio and credit quality as it relates to entire holdings, including your stock positions. Because of this, we believe passive funds still provide the best exposure for investors in that segment of the market.

In summary, data continues to support passive funds outperforming active funds across multiple asset classes and over most periods of time. This has persisted for many years and we expect it to continue into the future. On the whole, active fund outperformance is mathematically impossible as they charge more, and the sum of active management is the market as a whole. There also hasn’t been a model yet that can consistently identify active managers who will soon outperform. It seems the only group sure to benefit from active management is the fund managers who charge the high fees.

Trying to time the market is nearly impossible; there is no way to predict when the market is going to perform well and above what we expect it to. However, by buying and holding a low-cost, globally diversified portfolio, we know that we will not miss out on the returns of the top performing days in the market. Take the hypothetical situation below from our friends at Dimensional Fund Advisors which shows how the impact of missing just a few of the market’s best days can be profound.

A hypothetical $1,000 in the S&P 500 turns into $138,908 from 1970 through the end of August 2019. Miss the S&P 500’s five best days and that’s $90,171. Miss the 25 best days and the return dwindles to $32,763. There’s no proven way to time the market—targeting the best days or moving to the sidelines to avoid the worst—so history argues for staying put through good times and bad. Investing for the long term helps to ensure that you’re in the position to capture what the market has to offer.


Source: Dimensional Fund Advisors

Are you 70 ½ or older? Do you still need to take part, or all, of your required minimum distribution (RMD) from your IRA? Are you planning on making any charitable donations before the end of the year? If the answers to these questions are yes, consider making the charitable donation(s) directly from your IRA. According to the IRS, “[a] qualified charitable distribution (QCD) generally is a nontaxable distribution made directly by the trustee of your IRA (other than a SEP or SIMPLE IRA) to an organization eligible to receive tax-deductible contributions.”

Making a QCD excludes the distribution from income (up to $100,000 per person, per year), and counts towards your annual distribution requirement. Excluding the IRA distribution from income is more beneficial than taking a charitable deduction in most cases. However, for those taxpayers who will claim the standard deduction, making a qualified charitable distribution is even more attractive.

Jane, age 72, has a $1,000 distribution requirement from her IRA that must be taken by the end of the year. She also wants to make a $1,000 donation to her favorite qualified 501(c)(3) organization in December. Jane files a joint tax return with her spouse and has no itemized deductions besides her state income and property taxes, which are capped at $10,000.

Jane is better off making a qualified charitable distribution of $1,000 from her IRA to her favorite charity, rather than receiving the distribution and donating the cash. The reason is that Jane will take the $24,400 standard deduction under either scenario. Therefore, excluding the $1,000 from income is more advantageous than taking the income and a subsequent charitable deduction, which she will not actually end up taking on her return.

Making a qualified charitable distribution is fairly straightforward. Contact your IRA custodian, or Rockbridge advisor, and request a distribution. Make sure the check is made payable directly to the charity and not in your name. Request that no taxes be withheld from the distribution at either the federal or state level. Finally, have the check sent directly to the charity (if the custodian requires the check get sent to the IRA owner, make sure to forward the check to the charity as soon as possible).

If you are considering making a QCD, please keep in mind the following:

  • You must be at least 70 ½ year old when the distribution was made.
  • You must obtain an acknowledgement letter from the charitable organization containing certain information required by the IRS.
  • If your IRA contains both pre-tax and after-tax contributions, be sure you check with your accountant or Rockbridge advisor before making a QCD.

While making a QCD is generally more advantageous from a tax standpoint than taking the IRA distribution and taking a charitable deduction, everyone’s situation is different. Be sure to check with your accountant or Rockbridge advisor if you think this technique may be right for you.