Professional fund managers are extremely smart, highly educated, hard-working, and ultra-competitive. If you can perform in the top 2% of all professional fund managers on Wall Street, you're sure to find yourself with a very handsome payday at some point. Not to mention, you'll have proven to have the investment chops to take on more assets, earning more money in the future.
Surprisingly, it doesn't take all that much to come out ahead of 98% of professionals over the long run. You don't need a 160 IQ. You don't need an MBA or to work 80 hours a week studying the markets. And in an ironic twist, the less competitive you are, the better you'll be able to stick with a strategy that can lead you to after-tax returns that beat 98% of professionally managed mutual funds.
All you have to do is buy a broad-based index fund and hold it for years.
S&P Global publishes its SPIVA (S&P Indexes Versus Active) scorecard twice a year. The report details the performance of actively managed mutual funds relative to their closest S&P benchmark index over various periods of time. The most recent update found 90% of all domestic funds underperformed the S&P Composite 1500 index over the past 10 years.
The explanation is simple. Professional fund managers are operating in a two-sided market. For every fund manager that wants to buy shares of a stock, someone else must be willing to sell those shares. Due to the overwhelming amount of capital held and traded by institutional investors relative to small retail investors, the vast majority of the time the person on the other side of the trade is another professional. They can't both be right.
As a result, the average fund manager will produce returns very close to the market average.
But fund managers don't work for free and the companies they work for aren't non-profits. That's why mutual funds charge fees. And when you factor fees into the mix, it pushes the average fund manager well below the market average. Consistently outperforming a fund's fees over a 10-year period is an increasingly difficult challenge. That's seen in the fact that fewer and fewer actively managed mutual funds outperform the benchmark index (after fees) as more time goes on.
If it weren't enough that the vast majority of active fund managers consistently fail to earn their fees, real life makes things even more complicated. In real life, investors have to pay taxes. And more often than not, active mutual funds are very tax-inefficient.