Posted on 03/24/2025 8:43:28 AM PDT by JSM_Liberty
The results are in: this time is not different. Indexing remains the optimal investment strategy.
Every year S&P Global Ratings publishes reports comparing all actively managed investment funds with various stock indices. These reports are considered the gold standard for evaluating the performance of active fund management with their index-fund alternatives.
The bottom line from the year-end 2024 report out this month is that there were no surprises. US passive index funds in 2024 outperformed about two-thirds of actively managed funds. That is consistent with past results that also show that one-third of the managers who outperform in any single year are generally not the same as those who win the comparison in the next.
When you compound the results over 20 years, about 90 per cent of active funds produce inferior returns to low-cost index funds and indexed exchange traded funds. Equivalent long-term results were recorded for funds focused on developed economies, emerging markets and bonds. Even for small-cap funds, which had a good 2024, only 11 per cent outperformed over the past two decades.
It is not impossible to beat the market, but if you try, you are more likely to achieve the returns of the bottom 90 per cent of active managers. The evidence gets stronger every year: index fund investing is an optimal strategy for the ordinary investor.
Despite the evidence, many active managers argue that the future will be different. One common view is that the popularity of passive investing has created an unhealthy concentration of stocks in the popular indices and has made indexing an increasingly risky strategy. A second argument championed by some active managers is that index investors pour money into the market without regard to company earnings and growth opportunities. This compromises the ability of the market to reflect fundamental information, creates mispricing and thus permits active managers to use their skills to outperform in the future.
It is certainly correct that the market is highly concentrated. A few technology stocks (known as the Magnificent 7) have had a one-third weight in the S&P 500 index and were responsible in 2024 for more than half of the market’s 25 per cent total return. But such concentration is not unusual. In the early 1800s, bank stocks represented about three-quarters of the total stock market value. Railroad stocks constituted much of the total market value in the early 1900s, and internet-related stocks dominated the index in the late 1900s. And it is far from unusual for a small percentage of stocks to be responsible for most of the market’s gains. A study by Hendrick Bessembinder found that only 4 per cent of publicly traded US stocks have accounted for virtually all of the US stock market’s excess returns over Treasury bills since 1926. A concentrated market is not a reason to abandon index funds. Owning all the stocks in the market will ensure that you own the few stocks responsible for most of the market’s gains.
A second “this time is different” argument against indexing is that index funds have grown so fast that it has interfered with the market’s ability to price stocks even nearly correctly and to accurately reflect new information. Some have suggested that the growth of passive indexing has generated stock market bubbles such as the current boom in AI-related stocks. More investing without regard to fundamental information will enable active managers more easily to beat the index in the future.
There are logical and empirical reasons to reject such claims. Even if 99 per cent of investors bought index funds, the remaining 1 per cent would be more than sufficient to ensure that new information got reflected in stock prices.
And if one believes that bubbles will enable active managers to outperform, consider the data for the internet stock boom that expanded until 2000. Many internet-related stocks sold at triple-digit earnings multiples, far higher than the current valuations of today’s favourite AI stocks. SPIVA data shows that during 2001, 2002 and 2003, 65, 68 and 75 per cent of active managers underperformed the market in each of these “post-bubble” years.
The evidence grows more compelling over time. The core of every investment portfolio should be indexed and diversified across asset classes. Indexing will assuredly result in low fees and low transaction costs, and it is tax efficient. Index funds are also boring, and that may be one of their greatest advantages, less vulnerable to the waves of optimism or pessimism that characterise the financial news. As the white rabbit in the film Alice in Wonderland advises us, “Don’t just do something, stand there.”
Roger that.
“Sound advice.”
Have you ever had a situation where a formerly reliable increasing-dividend stock has cut back their dividend substantially?
If so, do you divest of it and move the money into other Steady Freddys ?
You may not have heard my anecdote about the industry.
Many decades ago I was finishing up my MBA and was being interviewed by various companies for jobs.
One of them was a major investment management firm.
They were trying to recruit me—and told me that as a new analyst I would be responsible for managing a billion dollars in assets.
I knew I was totally unqualified for that type of responsibility (since I had zero real world business experience) and immediately told them “no thanks”.
What a bunch of clowns.
The only way we see the end of Big Oil is is somebody makes it against the law. Not in our lifetimes anyway.
At $30 XOM was like printing money. Dang near the same for CVX. Both boards would sell their own children to keep paying a dividend. I used to tell the kids at CVX that the board would empty the office before they missed a dividend.
I saw a very similar thing in the management consluting business. A whole gang of well paid and newly minted bright kids without any experience led by one partner of the firm. What they told you was what your people have been trying to tell you Mr. Manager if only you would listen to them. Their process is formulary and the bottle and sell it over and over and over.
I laugh but feel a little sorry for the kids at the bank that are part of their offering of money management.
There is hardly any way that any money manager is actually culling and sifting through for the very best investments They all follow some kind of protocol. Sometimes it works and sometimes it doesn’t. All in all, if they stick to it they will be OK and you will come out below average. If you don’t like what they are selling you need to go somewhere else because they can’t afford the time to customize for your desires. They are too busy managing their package and selling more of it. That is the way the game is played and if you don’t like it you can go somewhere else or do it yourself.
Good point about the management consulting business...
What blew me away was that in the MBA program we were trained that every type of business had unique elements and if you did have an excellent understanding of those you were doomed to failure.
The “investment management” industry apparently could not care less.
Have you ever had a situation where a formerly reliable increasing-dividend stock has cut back their dividend substantially?
If so, do you divest of it and move the money into other Steady Freddys ?
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Yes, General Electric and that crook Jeff Immelt cut the dividend on me about 15 years ago. Also, during the mortgage meltdown I think a stock may have not increased its dividend one year. However, I also had a situation where Aflac dropped from $60 to $8 during 2009 when a report came out claiming they were highly leveraged with junk debt. Shortly thereafter, the CEO and other insiders bought up AFL stock, and I then bought myself, and now Aflac is at $110/share. Therein lies the problem with mutual funds. You are guaranteed below average returns, while one stock can power my portfolio to great returns.
On the other hand, over long periods of time, the advantage of the S&P 500 is that it automatically weeds out poor performers (International Paper) and adds up-and-comers.
The problem is the price weighting so you overweight on the (vastly overpriced) Magnificent 7.
FReegards!
Dividend Aristocrats.
There are no brokers or advisors that do not have a conflict of interest. NONE.
“These funds take almost 2% off the top,”
Index funds expense ratios are about a tenth of that
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You are correct that Index funds charge much lower fees, but there are hidden fees (12-B fees, etc.) that make it a little higher than what is advertised. The point I am making is that it is actually fairly easy to beat “average market returns” when you are not overseeing 5 billion dollars of $$. When a fund is that huge, it is a de facto Index Fund. They have very little flexibility, and they are always worried about their Morningstar rating. IMHO I think individuals would be better served by creating their own mutual fund, and then doing the opposite of what Jim Cramer advises!
On the other hand, over long periods of time, the advantage of the S&P 500 is that it automatically weeds out poor performers (International Paper) and adds up-and-comers.
Absolutely agreed.
I have had a couple of home runs, but they were not with large sums of money.
🥹
Speaking of conslutants. Try this one on. In the Treasury Department Booze, Allen and Hamilton get 80% or so of the contract revenue six months at a time for the last 20 years or so.
https://www.independentsentinel.com/sec-bessent-explains-the-grift/
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