Are You Overpaying for Underperforming Mutual Funds?

Listen to The ETF Store Show every Tuesday at 9am on ESPN 1510 as we cover everything you need to know about Exchange Traded Funds and the world of investing.

On our most recent radio show, we let the data do most of the talking.  The data we’re referring to is mutual fund expense ratio and performance data.   According to the Investment Company Institute, the average expense ratio for actively managed equity mutual funds is 1.44%.  Compare that to equity ETFs such as SPY or VTI, which have expense ratios of .09% and .05%, respectively.  On the subject of fund performance, data provided by S&P Indices, who is recognized as a global leader in providing benchmark data, show that last year almost 85% of actively managed domestic equity mutual funds underperformed their benchmarks, including over 95% of large cap growth funds.  Over the last five years, 62% of all active domestic equity mutual funds underperformed including over 80% of large cap growth funds.  Actively managed bond mutual funds have fared even worse over the last five years with over 96% of investment grade long bond funds and greater than 70% of global income funds underperforming their benchmarks.  Furthermore, for those active fund managers who may generate outperformance in a given year, there is no consistency to this performance over multiple years.  Per S&P Indices, for the five years ending March 2012, only 5.23% of large-cap funds, 5.46% of mid-cap funds and 5.14% of small-cap funds maintained a top-half ranking over five consecutive 12-month periods. Random expectations would suggest a rate of 6.25%.

These are staggering – almost unbelievable – numbers, but on our program, we explained exactly why actively managed mutual funds are so expensive and why they underperform the majority of the time.  The bottom line is that actively managed mutual funds seem to us to be a case of overpaying for underperformance.  At The ETF Store, we believe in low cost asset allocation using Exchange Traded Funds where we know we’re going to capture the benchmark returns minus fees – the same benchmarks that the majority of active mutual funds aren’t hitting.  Instead of trying to get lucky and find the 1 in 20 managers who may consistently outperform, we’re going to focus on diversification and being in the right asset classes at the right times.  Listen to the full show here to learn more about why we think ETFs are a better way to go for most investors.  Plus, catch our weekly market update and ETF Spotlight (ticker SDY).