What's going on with mutual funds

Question: I've had mutual funds for over 20 years that basically are about 10% higher now than my original investment so long ago. This is typical of most people I know; why do mutual funds give investors such crappy returns, when the major indices have more than tripled in the last 20 years? Rosanna, Walnut Creek, CA

Answer: Your experience is typical. It's the reason why so many investors have turned to low-cost index funds.

Yes, the pros are backed by an army of researchers and analysts comfortable with the markets. They tap into worldwide databases and manipulate powerful algorithms to uncover value in markets.

Problem is, most actively traded funds don't do well compared to the market and they charge hefty fees to boot (which in many cases is the real drag on returns). "Actively managed mutual funds consistently fail to produce superior returns," says David Swensen, the chief investment officer for Yale University's endowment fund and one of the country's most successful investors. "When taking sales charges into consideration, the failure of actively managed mutual funds reaches staggering proportions. In the final analysis, the benefits of active management accrue only to the fund management company, and not to the investor."

It's tough to beat the market even for the pros. Investing is the world's most competitive business. Astronomical sums change hands everyday around the world as millions and millions of smart investors (and many more not so smart ones) try to get an edge on the competition.

Thanks to hordes of investors, equity researchers, mutual fund money managers, journalists, day traders, hedge fund operators, corporate treasurers, pension fund managers, and others it's a challenge to find neglected diamonds among the zircon. Instead, what most money managers do is follow the trend of the herd.

Numerous scholarly studies have documented the relative poor performance of professional money managers compared to the market averages, such as the Standard & Poor's 500. The solution for many people is to invest in broad-based index funds. You can learn more about the perils of active management in a short book by long-time market watchers Burton Malkiel and Charles Ellis, The Elements of Investing.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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