Q. I’ve invested in index funds for years, but I’m starting to wonder if I could do better with actively managed funds. I also know it’s not fair to compare the fees for index funds and actively managed funds, but how can I compare the performance?
— Do-it-yourselfer

A. It all comes down to performance and how the fees charged by your mutual fund eat into your actual return.

Performance is easy to compare after expenses.

But year-to-date performance, or performance over one year or three, may be useful for bond investments, but not for stocks, said Debra Morrison, a certified financial planner with Empowered Retirement in Lincoln Park.

“Certain equity investment disciplines favor value over growth, small over large, blending of international and domestic, etc.” she said. “Stocks and stock investing strategies should be tested, or compared, over at least 7-year, if not 10-year rolling periods in order to glean an accurate picture of strategy or specific investment worthiness vis-à-vis performance.”

Morrison said investors would be capturing the market returns of 2008-2009 now only by looking at a minimum of a 7-year return, which will only be available once the 2015 year-end figures are in during the first quarter of 2016. Until then, 10-year performance numbers would be a safe barometer, she said.

While active investing can occasionally beat the indexed markets, you can get a good comparison with real numbers by looking at the SPIVA U.S. Scorecard, published twice a year by Dow Jones. This compares actively managed funds with the indices.

According to the 2014 year-end SPIVA, 86.44 percent of large-cap active money managers failed to beat the 2014 S&P 500 performance, while 88.65 percent and 82.07 percent failed to beat the S&P 500 Index over 5 and 10 years respectively, Morrison said.

“Scorecard also curiously identifies that the best performing asset class over the past 10 years has also produced the highest active manager failure rate,” she said. “91.81 percent of U.S. mid-cap active managers failed to best the 10.03 percent return of the S&P 500 Mid Cap 400 benchmark.

Morrison said while some active managers have touted their prowess in small-cap or emerging market asset classes — normally defined as ‘inefficient’ — the majority of active small cap money managers have failed to beat their benchmark in each of the 5-year rolling periods beginning in 2002.

“I, for one, don’t like any of these aforementioned active manager odds,” Morrison said. “Let me remove any mystique. Active managers believe they know something that the entire marketplace doesn’t know yet.”

She said they believe whatever they know isn’t built into the current price. So they make bets on that belief, or on those beliefs, yet the risk of those beliefs don’t translate into predictable returns in the markets as compared with those of the various indexes over time, she said.

“They employ big-name money managers who have recorded great numbers during some time, historically speaking,” she said.

Some time, not all the time.

Morrison said active management has huge marketing budgets to blast their “cunning sales talk” all over the internet, news and print media, plus television and radio, in order to keep their jobs.

“Think of the massive unemployment if more of the investing world went passive,” Morrison said. “Hopefully there’s not too much mystery left about their vested interest, which seemingly conflicts mightily with individual investors’ objective, which is to keep more of their own money in their pockets, not that of their broker.”

Morrison said the extra costs of trading within the active management world also contribute to yet more ‘hidden costs’ of active management, such as hefty income tax consequences, which drag overall net returns even lower.

“My overall advice is to follow the passive or asset class investing strategy that historically has kept more of your money in your pocket, not your broker’s, and stay the course long-term,” she said.

Email your questions to Ask@NJMoneyHelp.

Karin Price Mueller writes the Bamboozled column for The Star-Ledger and she’s the founder of NJMoneyHelp.com. Click here to sign up for the NJMoneyHelp.com weekly e-newsletter. Like NJMoneyHelp.com on Facebook and follow it on Twitter.

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