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Beware of the Mutual Fund Graveyard

By on July 9, 2013
Categories: FINANCIAL PLANNING

Forty six percent of mutual funds that existed in 1997 had disappeared 15 years later. According to a study released by the Vanguard Group this year, the mutual funds that vanished were usually the laggards. These doomed funds were underperforming their peers, which often meant that investor withdrawals were exceeding deposits.  In other words, shareholders were fleeing. During the 15-year period, 2,364 funds called it quits. The majority of them (1,915) were merged into other funds while the rest were liquidated. Investors who had selected a mutual fund on Jan. 1, 1997 had just a 22% chance of the fund outperforming its benchmark, whether or not it was merged.

Why Dead Funds Matter

Here’s why we should care about the mutual-fund casualty rate: When investment companies kill off or merge lousy funds, the category returns of surviving funds look more impressive. The chart below from Vanguard illustrates the boost that surviving funds can enjoy thanks to the mutual-fund graveyard.

 

 

The surviving stock funds in the large-cap value and large-cap growth categories (blue columns) clearly benefited from their fallen peers. Half of large-cap value funds, for example, outperformed their benchmark over a 15-year period, but that number drops to 27% when dead funds are included in the mix.  During the same time frame, the success rate for large-cap growth funds dropped from 34% to 18%. By the way, even reincarnation didn’t help the majority of mediocre funds. When looking at merged funds during the entire 15-year-period, 87% underperformed.

Bottom Line:

Even when the deck is stacked (dead actively managed funds are counted), investing in index funds has shown to be a superior way to invest.

Learn More…

Is It Possible to Outsmart the Market? Getting More Mileage from Your Retirement Portfolio

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