Heed the warning label on mutual funds – passive is better

The warning is posted in fine print at the bottom of all mutual fund advertisements: “Past performance does not guarantee future results.” The U.S. Securities and Exchange Commission requires it.

But when it comes to actively managed mutual funds, that warning should perhaps be updated to: “Strong performance almost certainly guarantees worse performance in the future.”

Such a caveat would simply reflect what the data tells us about actively managed funds, which are managed by a person or team instead of being “passively” pegged to an index or other benchmark. It also explains why retirement investors have been shoveling billions of dollars into passive total-market index funds and exchange-traded funds.

The latest nail in the coffin for active funds comes from S&P Dow Jones Indices, which this month released a semi-annual scorecard that tracks consistency of top-performing mutual funds over time. The study concludes that very few equity funds consistently stay at the top, especially after five or more years.

Only 7.33 percent of domestic equity funds that were in the top quartile of performance in March 2014 were still there two years later.

Only 3.7 percent of large-cap funds maintained top-half performance over five consecutive 12-month periods. For mid-cap funds, the comparable figure was 5.79 percent, and for small-cap funds it was 7.82 percent.

Learn more at Reuters Money.

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