Judgment in Managerial Decision Making, 8th Edition

CHAPTER NINE

Common Investment Mistakes

Because money managers are paid so handsomely for their work, investment banks often have their pick of the best and the brightest. It seems reasonable to assume that these smart, hard-working people—who are generously rewarded when their investments perform well—can find ways to invest your money that will perform better than a passive index-fund strategy of putting your money in an investment fund that tracks a broad market index of stock performances. Surely even a mediocre money manager ought to be able to hand-select stocks that would perform better than an index fund.

Well, let's look at the data. Over time, the Vanguard Index 500 fund, which tracks the S&P 500 (Standard & Poor's index of 500 large U.S. corporations), has outperformed about 75 percent of the actively managed mutual funds in each year. Of course, you personally would not plan to invest in one of the 75 percent of funds that performs worse than the market; you would choose from among the top 25 percent. The only problem is that substantial evidence demonstrates that past stock performance is not a good predictor of future performance. While some research suggests minor relationships between past and future performance, these relationships have been small and inconsistent. That makes it very difficult to identify which funds will be in the top 25 percent in the future.

There are a lot of mutual funds—approximately 8,000—and all of them are being managed by people who would ...