Common Sense on Mutual Funds: Fully Updated 10th Anniversary Edition

Chapter 9. On Selecting Superior Funds: The Search for the Holy Grail

Knowledgeable observers realize that the central task of investing is to gain the highest possible portion of the long–run return achieved by the class of financial assets in which they invest. But they recognize and accept that the portion will be less than 100 percent. As I have indicated in Chapter 4, a market index fund can provide 99 percent of the annual returns earned by its stock market benchmark, while the average actively managed stock fund can be expected to provide about 85 percent. While the future relative returns of managed funds are uncertain, it is difficult to imagine that they will rise to anywhere near 99 percent. Low-cost index funds, on the other hand, are almost certain to reach the 98 to 99 percent level, consistently over time.

As I noted earlier, even industry leaders are coming to recognize these realities, explicitly acknowledging (at least in one case) that "the average fund can never outperform the market." In fact, even those whose business is the promotion of actively managed funds cannot ignore these two poignant realities of the marketplace: (1) investors, as a group, do not, cannot, and will not beat the market, and (2) the overwhelming odds are against any particular mutual fund's doing so consistently over an investment lifetime. The real world of investing is not at all like Garrison Keillor's mythical Lake Wobegon, where "all of the children are above average."

Recognizing ...