Studies show these popular investments don’t perform

Physicians, like other investors, tend to believe that managed investment funds will protect them from market downturns, with their professional portfolio managers handpicking stocks. Recent data amassed during the pandemic’s market crash and rebound, however, demonstrate managed funds are not a good bet.

Looking at just the past-year performance, only four in 10 actively managed stock funds outperformed the average of their passive competitors in 2020, and researchers counted any outperformance in their analysis, even a slight one, according to Morningstar’s new Active/Passive Barometer report.

Over a longer time span, active stock funds fared even worse. Fewer than one in four active funds beat the performance of their passive rivals over the 10-year period that ended in December 2020. Results were even worse among large-cap funds. Generally, long-term success rates were higher among foreign stock, real estate, and bond funds, the report found.

Still, actively managed funds accounted for the majority of US fund assets (61%) at the end of 2019, according to the Investment Company Institute’s 2020 Factbook, suggesting that many physicians’ portfolios could use an overhaul.

It may be time to revisit your investment strategy

“Active funds are highly profitable for the fund companies so fund companies have gotten very good at selling the possibility of outsized returns based on some smart-sounding strategy,” said Anthony Watson, CFA, CFP, of Thrive Retirement Specialists, in an exclusive interview with MDLinx. “While it’s true there is always a possibility, the statistics show time and again it is not probable. Investors should invest based on probability over possibility.

“I believe the time to use passive funds is always,” Watson said. “In the stock market, it’s a zero-sum game. There are winners and losers, and active funds don’t win over time. Can you tell me when the market is going to go up or down?  You’re much better off not playing that game.”

Working with a financial advisor may reap the best results. “[One of the biggest] mistakes I see highly compensated investors make is thinking they have the free time to manage their investments well,” Robert Stoll, chief financial officer at Financial Design Studio, told MDLinx. “Too often, physicians are extremely busy and end up ignoring their portfolios and doing whatever is easiest. This can cost them dearly when markets are volatile and they’re trying to catch up on investment and retirement goals.”

Please see Expert guidance for doctor retirement portfolios.

Are your indexed investments headed for a drop?

The past two decades have seen explosive growth of “passive” fund investing, namely mutual funds and exchange traded funds (ETFs) tied to an index, such as the S&P 500 or the Dow Jones Industrial Average. These investments held total net assets of $22 trillion in 2019, compared to $8.5 trillion 10 years prior, according to the Factbook. They use a buy-and-hold philosophy to replicate the return on the index they track, such as the S&P 500 or Dow Jones Industrial average. They don’t try to beat the market, rather they are the market. They generally offer investors lower fees, lower taxes, and greater transparency about their day-to-day holdings. 

“Index funds make no judgments about individual company valuations and simply sit and quietly hold everything,” Watson explained.

While many investors have poured money into investments indexed to the S&P, their luck may be about to end. “The S&P 500 has been kicking butt for the last 10 years. It’s beaten small caps, international, emerging markets. It’s had this unprecedented run, fueled by the tech sector and this economic expansion we’ve been seeing,” Watson said. But investors beware: “There are strong signs the S&P is overvalued right now and could be headed for a price correction.”

Stoll agrees. “The biggest sign of overvaluation we see in large-cap stocks is the concentration of the S&P index. The 10 largest companies make up 27% of the index. That’s the highest concentration we’ve seen since the 1970s.” 

Rather than choosing  investments tied to the S&P 500, Watson advises his clients to select broader exposure for better returns. “Returns in any given year do not come linearly from all assets. Often the vast majority of return in any given year is driven from a small segment of the market,” he explained. “Given that the S&P 500 only represents the largest 80% of companies, I would be concerned about missing exposure to the remaining 20% of the market. What if it’s that other 20% that generates the greatest proportion of return in future years?”

Watson advises his clients to invest in index funds that follow the Wilshire 5000 or the CRSP US Total Market. This allows investors to profit from the smallest 20% of companies whose potential for growth could be greater and whose current valuations are not as high, he said.

Please see Here’s where doctors should put their money.

Choosing the right index to follow 

It’s important to look under the hood of any indexed investment options. “The biggest issue we have with passively managed funds is that some track indexes that aren’t well diversified or that have embedded risks of which investors may not be aware,” Stoll pointed out. “For example, the most popular so-called ‘diversified’ emerging market stock ETFs allocate close to 40% of funds to China. That means they might now be as well-diversified as what you need.” 

Stoll advises physicians to protect themselves from market volatility by ensuring they are well-diversified. “Just because you own a dozen funds doesn’t mean you’re well diversified, if they  own the same stocks and are strongly correlated.” 

One big consideration when choosing funds is fees, which eat away at investors’ returns, year after year. Although fund fees have been on the decline due to intensifying competition and increasing investor awareness, there is still a wide gap between active and passive funds, according to Morningstar’s latest US Fund Fee Study. For example, for large cap blend funds, actively managed funds average fees of 1.01% whereas passively managed funds come in at 0.40%.

Morningstar also found that the active funds with the lowest fees are twice as likely to beat the market. In fact, 34% of the cheapest funds beat the market vs only 16% of the priciest ones, writes Morningstar’s Ben Johnson, CFA in a blog post. 

“Cost matters. Fees are the one of the best predictors of future fund performance,” the Active/Passive Barometer study concludes.

To read more about physician investment, please see 5 improvements doctors can make to their financial portfolios.