Test Your Mutual Fund IQ

A lack of basic financial knowledge could be hurting your investment returns.

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It’s a sad state of affairs that so many investors are misinformed by the financial media and their brokers and advisers. As a consequence, investors are not capturing market returns that are theirs for the taking. Instead, they are engaged in the mug’s game of trying to “beat the markets.” They chase returns, relying on past performance, in the mistaken belief it is likely to persist. They jump in and out of the markets, based on the news of the day, unreliable technical “signs” and self-anointed stock-picking gurus.

Help is on the way, thanks to eye-opening data collected by Dimensional Fund Advisors that I am sharing in the form of a Q-and-A. I suspect many of you will be surprised by this information. I hope it will inform the way you invest.

Q: How much is invested in stock and bond mutual funds?

A: $11 trillion as of 2012.

Q: What percentage of actively managed stock mutual funds survived for the 10-year period, ending in 2012?

A: Only 51 percent.

Q: Of those that survived, what percent of actively managed stock mutual funds beat their respective benchmarks over that period?

A: Only 17 percent.

Q: What is the primary reason why so many funds did not survive?

A: Poor performance.

Q: Why do the financial media pay so little attention to funds that don’t survive?

A: Doing so would make it difficult to convince you that the fund managers on their shows will even survive, much less beat their benchmarks.

Q: Are funds that beat their benchmark likely to continue their outperformance?

A: No. Only about a quarter of the stock funds with outperformance during the initial three-year period (2007–2009) continued to beat their benchmarks in the subsequent three-year period (2010–2012).

Q: Is there any way to reliably and consistently select fund managers who are likely to outperform their benchmarks in the future?

A: No. Don’t assume past performance is likely to persist.

Q: What impact do costs (expense ratios) have on the performance of actively managed stock mutual funds?

A: Costs significantly and adversely affect returns. Over the 10-year period ending in 2012, 21 percent of the low-cost funds outperformed, compared with only 10 percent of the high-cost, actively managed funds.

Q: What other factor is likely to adversely affect returns of stock mutual funds?

A: High trading costs. Funds with higher turnover are likely to underperform funds with lower trading costs. For the 10-year period ending in 2012, 24 percent of the funds in the lowest quartile of trading costs outperformed their benchmark, compared with only 10 percent of those in the highest quartile.

Q: Now that you understand that outperforming stock funds may not even survive, those that do are unlikely to outperform their benchmarks, strong track records fail to persist and high costs and excessive turnover contribute to underperformance, why would you continue to invest in actively managed funds in an effort to “beat the market?”

A: You wouldn’t.

Q: Why are you learning this information from this blog post and not from the financial media or your broker or adviser?

A: Because they understand that if you knew this data, you would stop watching their inane shows and stop using their brokerage and advisory services.

Dan Solin is the director of investor advocacy for the BAM Alliance and a wealth adviser with Buckingham Asset Management. He is a New York Times best-selling author of the Smartest series of books. His latest book, 7 Steps to Save Your Financial Life Now, was published on Dec. 31, 2012.

The views of the author are his alone and may not represent the views of his affiliated firms. Any data, information and content on this blog is for information purposes only and should not be construed as an offer of advisory services.