How many of us would list luck as the key ingredient for a top performing mutual fund? That’s certainly not the message we receive from most mutual fund companies that stress the expertise and trading skill of their top managers. Interestingly, however, a new study by internationally renowned finance professors Eugene Fama and Kenneth French finds that luck plays a bigger role than skill in determining a fund’s success.
Although investors pay well over $10 billion annually in fees to managers of actively managed funds, Fama and French found that active funds’ returns actually trail their passive benchmarks by approximately the level of the funds’ expense ratios (around one percentage point per year). Furthermore, the professors found that even the small number of managers (just 3%) who cover their costs are unlikely to noticeably outperform a large, efficiently managed index fund in the future.
The current Fama and French study is another in a substantial body of academic research that clearly illustrates the folly of chasing past returns. It also underscores the wisdom of taking a passive approach to investing to secure the superior long-term results upon which your retirement depends.