Economist Burton Malkiel penned what is perhaps the most vivid metaphor for describing the difficulty of picking winning stocks. In his groundbreaking book, A Random Walk Down Wall Street, he wrote, “A blindfolded monkey throwing darts at a newspaper’s financial pages could select a portfolio that would do just as well as one carefully selected by the experts.”1
While you might question the wisdom of tying a blindfold on a monkey and handing him a fistful of darts, you can’t question the evidence that even the most brilliant financial minds cannot consistently predict the future movements of the market with certainty.
First, let’s look at the recent short-term.
Bob Pisani, writing for CNBC, says, “For decades, active managers have claimed that in boring markets, don’t expect them to outperform. When things change fast, however, when there are rapid changes in the economic outlook and high volatility in the markets, active managers can make quick decisions that will crush their passive competitors.”
The historically volatile markets of 2020 and 2021 have provided a prime opportunity to test this hypothesis.
It didn’t hold true.
A study by Morningstar of 3,000 active funds (from the latter half of 2020 through the first half of 2021) found that only 47% survived and beat their average passive counterparts. That’s a little worse than a coin toss.
A report from S&P Dow Jones Indices came to a similar conclusion. Over the same period, 58% of large-cap funds, 76% of mid-cap funds, and 78% of small cap funds trailed the S&P 500, S&P MidCap 400, and S&P SmallCap 600, respectively.
And when you look at a long-term horizon, the average lag in performance is even worse.
Over a 10-year period, only 25% of all active funds beat their passive counterparts, according to Morningstar. Among large-cap equity funds, which are what most investors hold, only 11% of managed funds beat their passive peers.
Pisani explains that fund managers may get a hot hand for one, two, or three years, but it rarely lasts. The longer the time horizon, the harder it is to beat the averages.
Active fund managers are among the smartest people on Wall Street. So why is it so hard for them to outperform Malkiel’s blindfolded monkey?
Larry Swedroe, director of research for Buckingham Strategic Wealth, explains that to produce index-beating results active managers have to be lucky twice each time—going into and coming out of the market. And then there are the fees.
“Even if an active manager managed to outperform,” Swedroe says, “high fees and trading commissions eat into whatever excess performance (alpha) they are able to generate.”
Stock pickers occasionally get lucky in the short-term. But if your goal is a fully-funded retirement, then you’re wise to choose a long-term, broadly diverse strategy—one that anticipates having to endure the unknowable future movements of the market. And then keep to that strategy with the help of a trusted advisor.
Sources: 1. http://go.pardot.com/e/91522/gers-underperformed-again-html/74sb6v/1358018059?h=DSqvBl61jcTW1dX3CNa5pqTt2g61Ey9qn8l519ovef0 Disclosure: The views expressed herein are exclusively those of Efficient Advisors, LLC (‘EA’), and are not meant as investment advice and are subject to change. All charts and graphs are presented for informational and analytical purposes only. No chart or graph is intended to be used as a guide to investing. EA portfolios may contain specific securities that have been mentioned herein. EA makes no claim as to the suitability of these securities. Past performance is not a guarantee of future performance. Information contained herein is derived from sources we believe to be reliable, however, we do not represent that this information is complete or accurate and it should not be relied upon as such. All opinions expressed herein are subject to change without notice. This information is prepared for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. You should seek financial advice regarding the appropriateness of investing in any security or investment strategy discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. You should note that security values may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Investing in any security involves certain systematic risks including, but not limited to, market risk, interest-rate risk, inflation risk, and event risk. These risks are in addition to any unsystematic risks associated with particular investment styles or strategies.