digest
Short Summary
Main recommendation: Avoid Dave Ramsey's investing advice to pick high-fee actively managed mutual funds based on strong past returns, and instead use low-cost total market index funds, which Ben Felix argues are the best investment for most people. Felix contends that fees are among the most reliable predictors of future fund performance, while past outperformance is largely luck rather than manager skill.
Key Points
- Ramsey argues returns matter more than fees, and that you should pick funds that beat the S&P 500; Felix says this is flawed because past-beating funds are not reliably likely to keep beating the market.
- Citing William Sharpe's 1991 "The Arithmetic of Active Management," Felix argues that after higher average active fund costs, the average active dollar must underperform the average passive dollar.
- Morningstar research, cited by Russell Kinnel, found low-cost funds beat high-cost funds in every time period and asset class tested, making expense ratios a strong predictor of performance.
- S&P's SPIVA Persistence Scorecard found only 0.7% of top-quartile funds (4 of 569) stayed in the top quartile over five years, suggesting past outperformance does not persist.
- Survivorship bias inflates mutual fund results: after correcting for it, S&P's SPIVA scorecard found 89% of active U.S. funds failed to beat their benchmark over 15 years, and only 43% of funds survived that period.
Details Worth Noting
- Concrete instructions: Felix's actionable guidance is to avoid picking actively managed mutual funds on the basis of past returns or beating the S&P; instead, consider low-cost total market index funds, or, for higher expected returns, small cap and value index funds at about 0.2% or less in fees, rather than paying around 2% for an active manager.
- Felix says that when evaluating funds, expense ratios should be weighted heavily, because they are one of the most important factors for choosing an investment on average.
- Felix claims small cap value stocks returned 15.89% annualized over the 40 years ending April 2018 and 13.95% over 30 years, outperforming the S&P 500 over those periods.
- Felix quotes Dave Ramsey, who claims the mutual funds he's personally invested in averaged 13.04% over 40 years versus 11.81% for the S&P, but Felix counters that small cap value index funds outperformed both over the same periods, suggesting even that outperformance could reflect risk exposure rather than skill.
- Felix notes that fund outperformance in the cited studies was measured against passive index exposure to the same stock types, so apparent manager skill can simply reflect higher-risk factor tilts.
- Felix does not provide the names of Dave Ramsey's specific funds and says he does not know what is in Ramsey's portfolio.
Bottom Line
Ramsey's guidance to chase past-performing active funds is, in Felix's view, contradicted by academic and empirical evidence, so low-cost index investing is the safer default for most investors.
