Mutual funds fall into two categories:  active and passive.  While most investors, sadly, fall for salesmanship.

Long term, after taxes and fees, a diversified portfolio of index funds stands the highest statistical chance of beating a diversified portfolio of actively managed mutual funds.  No academic study refutes that.  But the average investor is fooled by advisers–who make their living selling actively managed mutual funds.  Why does anyone buy actively managed mutual funds for taxable accounts?

Annual costs of just 2.7% extra per year can mean that the average investor will only have half the proceeds they deserve when they retire—thanks to excessive costs and advisers’ conflicts of interest.

And if you invested $10,000 over 55 years, the difference of just 2.7% in fees or extra taxes, are simply devastating:

  • $1,144,082 ($10,000 earning 9% per year and compounding annually for 55 years)
  • $   190,057 ($10,000 earning 6.3% per year and compounding annually for 55 years)

There’s nearly a one million dollar difference!

Don’t listen to salesmanship.  Listen to the true financial experts:

What does Warren Buffett say, the second wealthiest man on earth, and arguably the greatest investor in history?

  • “Full-time professionals in other fields, let’s say dentists, bring a lot to the layman.  But in aggregate, people get nothing for their money from professional money managers…The best way to own common stocks is through an index fund”

–Warren Buffett

or how about?

  • “The most efficient way to diversify a stock portfolio is with a low fee index fund”

–Paul Samuelson. the first American to win a Nobel prize in Economics.

But maybe Buffett and Samuelson don’t t know anything about money, you might suggest.  OK–how about another Economic Nobel laureate (none of which, by the way, have published relative statements other than those echoing this one):

  • “More often (alas), the conclusions [supporting active mutual fund management] can only be justified by assuming that the laws of arithmetic have been suspended for the convenience of those who choose to pursue careers as active managers”

–William F. Sharpe, Nobel Laureate in Economics, 1990.  “The Arithmetic of Active Management,” Financial Analysts’ Journal, Vol. 47, No1, January/February 1991.

And if all the data supports indexes over actively managed mutual funds, why doesn’t your financial adviser agree, and/or put your money into index funds (the leader, of which, is a company called Vanguard)

  • “When brokers realize that they won’t be compensated for putting our funds in a plan, they typically hang up on us”

–Vanguard, director of institutional sales

But how about Peter Lynch?  He’s the rock star mutual fund manager whose Fidelity Magellan fund caught investors’ imagination for years, as it spectacularly performed.  Since those heady days, his fund has been easily surpassed by the U.S. index, and he has this to say:

  • “The public would be better off in an index fund”

–Peter Lynch

But he was the rock star fund advisor from the 1980s.  His time has passed, you might say.  Perhaps.  But can you think of a more notable fund manager than Bill Miller?  He may be the most famous mutual fund manager of all time–one who beat the S&P 500 index for years.  (Since then, of course, the index has caught and surpassed his fund):

  • “[A] significant portion of one’s assets in equities should be comprised of index funds.”  “Unless you are lucky, or extremely skillful in the selection of managers, you’re going to have a much better experience going with the index fund”

–Bill Miller, Legg Mason Value Trust fund manager

Some mutual fund managers, of course (these are guys who actually run the funds) are mandated to buy shares in the funds they run.  But in taxable accounts, if fund managers don’t have to do that with their own money, they generally won’t.  Ted Aronson actively manages more than $7 billion for retirement portfolios, endowments and corporate pension fund accounts.  He’s one of the best in the business.  But his own taxable money?:

  • “..all our [his family’s] taxable money is in Vanguard’s no-load index funds”

–Pg. 150, The Lazy Person’s Guide to Investing, Paul Farrell

And in an interview with Jason Zweig, of Money Magazine, Ted Aronson said this:

  • “Once you throw in taxes, it just scewers the argument for active management….indexing wins hands-down.  After tax, active management just can’t win.”

While notable investment author, William Bernstein agrees:

  • “While it’s probably a poor idea to own actively managed mutual funds in general, it is a truly terrible idea to own them in taxable accounts…[taxes are] a drag on performance of up to 4 percentage points each year…For taxable investors, indexing means never having to say you’re sorry”

But what would the BIGGEST seller of mutual funds tell you?  Well, billionaire Charles Schwab probably sells more mutual funds through his brokerage business than anyone has.  And when recently asked by Money Magazine’s Jason Zweig, where young people should put their money, he steered them away from actively managed mutual funds:

  • “I’m more of an indexer..the predictability is so high…For 10, 15, 20 years, you’ll be in the 85th percentile [before taxes].  Why would you want to screw it up?”

But how about some kind of real authority–like a former chairman of the American Stock Exchange and the U.S. Securities and Exchange Commission?

Well, here he is.  In Arthur Levitt’s own words:

  • “The deadliest sin of all is the high cost of owning some mutual funds.  What might seem to be low fees, expressed in tenths of 1 percent, can easily cost an investor tens of thousands of dollars over a lifetime”

But financial advisers are really smart.  Even if, as Yale University’s David Swenson suggests “…the market failure resulting from the mutual-fund industry’s systemic exploitation of individual investors requires government action” you should still be able to find a great advisor who can help you buy the best mutual funds, even if they’re statistically, brutally inefficient.  Right?  Wrong.  As an aggregate, financial advisers tend to do worse, when picking mutual funds, than the average independent investor does.  Fund managers buy more expensive products, which benefit themselves, in the forms of higher commissions and trailer fees:

“the weighted average return of equity funds held by investors who relied on advisers (excluding all charges paid up front or at the time of redemption)–averaged just 2.9% per year–compared with 6.6% earned by investors who took charge of their own affairs”

Harvard Business School study from 1996 to 2002

Pg. 104 The Little Book of Common Sense Investing, John Bogle

And if you still want to take the risk of buying actively managed funds in a taxable account, on your broker’s advice, keep this in mind:

  • “A miniscule 4 percent of funds produce market-beating [index beating] after-tax results with a scant 0.6% (annual) margin of gain.  The 96% of funds that fail to meet or beat the Vanguard 500 Index Fund lose by a wealth-destroying margin of 4.8% per annum”

–David Swenson, Chief Investment officer of the Yale University Endowment Fund

Other notable quotes:

  • “For now, at least, the old saying still seems apt:  Mutual funds are sold, not bought”

–Jonathan Chevreau, Financial Post

  • “There’s no greater pitfall than the one created by the retail mutual fund industry. [They] are ripping you off”

–Ric Edelman–Inductee in the Financial Advisor’s Hall of Fame

  • “After examining thousands of funds, Siggelkow concluded that fund managers do exploit opportunities to maximize fees, often using techniques that make fees virtually invisible to investors”

From Knowledge@Wharton, based on Nicolaj Siggelkow’s (Wharton management professor) study of mutual funds costs, Wharton School of Business

  • “Santa Claus and the Easter Bunny should take a few pointers from the mutual fund industry.  All three are trying to pull off elaborate hoaxes”

–Jonathan Clements, The Wall Street Journal, September 15, 2002

  • “Before you jump into [actively managed mutual funds] consider the cost:  typically 2 percent to 3 percent of your assets per year….You are simply giving your money away”

–Jane Bryant Quinn,, May 19, 1996

  • “Your chances of selecting the top performing funds of the future on the basis of their returns in the past are about as high as the odds that Bigfoot and the Abominable Snowman will both show up in pink ballet slippers at your next cocktail party.  In other words, your chances are not zero–but they’re pretty close”

–Jason Zweig, author of the revised edition of The Intelligent Investor, pg. 245

  • “Whenever we lay out the math, people are naturally skeptical.  It seems too good to be true.  How can the mutual fund industry get away with charging us so much for so little?  Doesn’t all that expensive professional management accomplsih something?  Sadly, no.”

–Ian McGugan–Editor of MoneySense magazine

I would love to see an opposing study contradicting the above statements.  But after reading more than 270 finance books, I haven’t seen one.  I’d love it if someone could show me one.  But sadly, it doesn’t exist.

You and your friends can’t afford to buy actively managed mutual funds.  It feeds an industry that makes more money (in fees) over 6 weeks, than Warren Buffett made in a full 78 years  (the industry reaps more than $400 billion a year from investors).

Sadly, many people pay “wrap fees”—which are portfolio management fees, where they pay advisers an annual percentage of their assets each year to choose actively managed stock and bond funds for them.  These fees are on top of the extra taxes they pay, and the regular, inhibiting mutual fund costs they pay. Wow.

  • “Wrap fee accounts may be great for the ego, but they’re bad economics.”

–Frank Armstrong, author of The Informed Investor

If you want to see how a very simple portfolio of indexes has performed since 1976, have a look here.  This portfolio constitutes 33% in a government bond index, 33% in a Canadian stock index and 33% in a U.S. stock index.  MoneySense magazine wanted to compare the results with the average actively managed mutual fund, but the publishing company (which receives much of its advertising money from the mutual fund brokerage industry) would not allow them to publish that.

CCPP: Historical performance tables

More Information:

Real Costs Of Mutual Funds Hidden

How To Measure The True Cost Of Holding A Fund

Can You Afford to Invest in Mutual Funds?

Performance of Indexed vs Actively-Managed Portfolios for the 15 years Ending 31-Dec-2007