You wouldn't bet your retirement savings on a 1-in-5 chance--or would you? Check your latest mutual-fund statement. You may be gambling more than you know.
One of the fund industry's not-so-funny little quirks is that most stock-fund managers can't beat important benchmarks like the Standard & Poor's 500, even though they try with all their might. That index represents the average stock. In theory, half of all funds should beat it while half fall short. In reality, in the past 10 years only 20% of diversified, actively managed U.S. stock funds have done better. Laggards include big names such as Income Fund of America, with assets of $16 billion, and Fidelity Puritan, with assets of $19 billion.
In plain English, fund lovers, that means the vast majority of you, through fees levied against your funds, have been paying professionals for the privilege of earning subpar returns. That's only supposed to happen in baseball. Last year just 25% of stock funds matched the S&P 500. In 1995 the number was a pitiful 16%, and in 1994 it was 23%, according to Lipper Analytical Services. If fund managers simply threw darts at a stock table, you'd expect more to match the benchmark.
This is no small matter. Over time, lagging stock funds take a huge bite out of what you might have earned. During the past 10 years, the average stock fund rose 260%, vs. 314% for the S&P 500. If you had invested $10,000 in the average fund, it would have become $36,000; in the S&P 500, $41,400--15% more.
What are you doing about this problem? Throwing more money at it. The public pumped an estimated $223 billion into stock funds last year, nearly all of it into actively managed funds. It has been amply rewarded. "Measured against where all the money was 10 years ago--in banks--they've done great," says Robert Schmidt, president of Individual Investor Group, a financial-magazine publisher. He's right. Even bottom-tier funds in the '80s and '90s have been good enough to embarrass bank CDs, the likely repository for savings that aren't in stocks. Still, people left CDs for a reason. Having correctly made that tough decision years ago, they should not be grateful now for lackluster results. Even though their money on the whole has more than tripled in stock funds in 10 years, it could have quadrupled if only more managers were simply average.
There have been plenty of good funds, of course. In the same 10-year period, Twentieth Century Giftrust rose a whopping 617%--turning $10,000 into $71,700. FPA Capital jumped 595%; PBHG Growth Fund popped 589%. And the really good news is that the 20 largest stock funds, which together account for nearly a third of all assets in domestic stock funds, have come much closer to matching the S&P 500 than most. If you own any of the winners, count your blessings. Just don't count on continued outperformance.
The sad fact is that fund investors have the deck stacked against them when it comes to beating the averages. Here's why: