Active management: a fool’s paradise?

By Mark Brown | March 31, 2006 | Last updated on March 31, 2006
2 min read

If you’re selling mutual funds, pushing equities or recommending some other actively-managed product then you are a fool — at least according to a consortium of top-fee only advisors in the U.S.

The group, led by Mark Hebner, founder of Index Funds Advisors of Irvine, California, has dubbed April 1 as Index Funds Day in a tongue-in-cheek reference to all the “fools” who think they can outperform a market average or index given the unpredictability of news and the randomness of stock prices. (Although not stated on the group’s website, one can assume he hasn’t factored in famed stock pickers such as Warren Buffet, Peter Lynch, John Templeton and the like).

“The active money management “you can beat the market” hoax, is dangerous because it has fooled investors into thinking that their money managers can beat the market by forecasting the next news story that will move market prices,” according to the Index Fund Day press release. “The fact is, news is random and cannot be predicted. Likewise, stock price movement is volatile, so picking stocks is largely a matter of luck, and success cannot be sustained over time.”

“Active management is hazardous to your health,” Hebner adds. To back up his point, he cites “top academics and Nobel laureates” who found index funds will preserve and enhance an individual’s portfolio over the average 30 to 50-year investment lifetime. Compounding the problem, commissions, management fees, margin costs and taxes erode whatever gains are made.

Due to these costs, he continues, “you will slowly transfer your money in to the pockets of stock brokers, mutual fund managers, hedge fund managers, and the many other individuals profiting form your numbers transactions and your lack of understanding of free market principles.”

Index funds are intended to reduce risk without changing the expected return. They’re also cheaper. Last year, Barclays Global Investors Canada said “fee freedom day” for Canadian mutual fund investors is generally in April. Last year it was April 27, the year before it was April 12. “Fee freedom” for index funds, however, came three months earlier, due to their lower fees.

“Fee freedom” — when investors start earning returns for themselves — is just another way for investors to see the impact of mutual fund costs. As Howard Atkinson, head of public funds at Barclays said last year, “Costs are the only piece of the investment puzzle that mutual fund investors can actually control.”

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Mark Brown