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In a recent segment on his radio show, Dave Ramsey said, “The last 30 years, my portfolio has averaged over 12%, most years over 13%. It’s not difficult to beat the S&P 500. The S&P is just the average of the market.” My mind was racing when I saw this clip making its rounds on social media. First, are his return numbers actually valid? And second, is it really that easy to beat the S&P 500?  

I went to Morningstar, a Chicago-based independent investment research firm that compiles and analyzes fund, stock, and general market data, to look up the answer to the first question. Mr. Ramsey is a huge proponent of actively managed mutual funds and talks about them often on his show and website as core to his investment philosophy. I looked at large-cap mutual funds to see how many, over the prior 30 years, averaged more than 12% to try and understand how easy it would be to get to his magical returns over time. Unfortunately, Morningstar data only goes back 20 years, so I made do with a 20-year timeframe. Two thousand three hundred seventeen large-cap U.S. mutual funds have 20-year returns data in Morningstar. Of those, only 41 have averaged more than 12% over the last 20 years. The entire 41 tilted to large-cap growth (relying heavily on higher volatility investments in areas like technology), and 12 were index tracking (tracking the Nasdaq 100). 

So, of actively managed funds, 29 out of 2,317 were able to hit his 12% target. A staggering 98.75% failed to meet this return. The 2,317 mutual funds considered do not account for how many mutual funds in the large-cap US space have gone out of business or been liquidated over the past 20 years, which would likely drop your chances of picking a fund that did better below 1%. 

Having looked at Mr. Ramsey’s self-proclaimed returns, I focused on finding out how easy it is for a manager to beat the S&P 500. Luckily, Standard and Poors (S&P) publishes an annual report detailing this information. It’s called the SPIVA (which stands for S&P Indexes Versus Active) report, and it offers a pretty bleak assessment of finding an active manager that can beat the index over time (the data in the following chart is as of 12/31/2022). 

CHART ONE:   Source – S&P Dow Jones Indices, CRSP.

Chart 1 shows that a manager trying to beat the S&P 500 has a chance in the short term — say one to three years. Still, there is only a 50/50 chance of picking a manager who beats the index over one year and a little over 25% chance to pick a winner over three years. Once you extend out to 10 years, your chances of selecting an active manager that can beat the index drops to 10% and around 5% when you extend to 20 years. The tendency for indexes to outperform actively managed funds over time plays out in most market areas. If you’re interested in seeing the research, check it out here: spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2022.pdf

Why does low-cost indexing beat active management over time? The main culprit is management and trading costs. When you think about investing, it’s a zero-sum game. If I buy a stock, someone must sell it to me. Every trade has a buy and a sell attached to it. The average index investor will get the market returns over time, less the fees they pay. Active management costs more as they strategize to beat the market by trading more frequently and overweighting certain stocks and industries. If humans could get it right, it’d be worth it. Unfortunately, the data tells us it’s nearly impossible.  

Ultimately, at KWB, we’re long-term investors for our clients. We want the best value with the highest expected return for clients, and sometimes that means getting the average return (the index). There can be a place for active management in portfolios, and we make that choice based on research and if it fits the client’s financial plan. Nevertheless, being average year in and year out will likely put your returns ahead of most of your friends and neighbors.     

Quick Market Thoughts  

CHART TWO:   Carson Investment Research, YCharts.

Both August and September were struggles for the stock market, but some of that was to be expected. The S&P 500 advanced nearly 20% for the year, and historically, August and September are months when the market is known to take a pause (see Chart 2). 

 The good news is that we’re now entering the fourth quarter, which has shown much market strength in the past. So, hopefully, we’ve lived through the worst of what this year had to offer. As of this writing, the S&P is still up over 12% for the year, which is nothing to sneeze at. Our outlook continues to be no recession in the foreseeable future, which should mean higher earnings for corporations, leading to higher market prices.   

As for the conflict in Israel, our thoughts are with the region’s people as the terrorist group, Hamas, has begun a new war in the area. These geopolitical incidents seem to be becoming more regular these days, which is a travesty for the world. That being said, these conflicts tend to be blips on the radar regarding investing. Historically, there is a tendency for money to flow to more stable nations (like the U.S.) in both the bond and stock markets as a flight to “safety” occurs.   

As always, if you have any questions or your financial situation has changed (beneficiaries, income needs, investment objectives, time horizon, risk tolerance, etc.), don’t hesitate to contact our office, and stay safe.  

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.  To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

All performance referenced is historical and there is no guarantee of future results.  All indices are unmanaged and cannot be invested into directly.

The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

Investing involves risk including loss of principal.

No strategy assures success or protects against loss.  The economic forecasts set forth in this newsletter may not develop as predicted and there can be no guarantee that strategies promoted will be successful.