Sometimes sitting on your hands is a much better idea than jumping in and out of the stock market. Your performance is better over time.
I'm referring to making a choice in your portfolio on whether to be active or passive. The former strategy assumes that you or a manager know the best time to be in stocks and when to leave the market. A passive strategy, represented by index mutual- or exchange-traded funds holds onto a basket of securities all the time.
Of course, every investor can make this choice. You can choose funds in your 401(k) that are actively or passively managed. Even target-date funds, which hold a variety of funds, give you that choice.
Shall I stay or shall I go? Active vs. passive? Which is best? It's essential that you look at some reliable research to make this decision. Standard and Poor's/Dow Jones Indices prepares a "SPIVA Scorecard" on a regular basis to track returns of mutual funds on this score.
The latest SPIVA Scorecard, which covered the period through the end of last year, measures the performance of actively managed funds against static benchmarks that track the performance of the broad stock and bond markets.
Who did the best? It depends upon the category of investing observed. Keep in mind that within the stock market, there are large, mid-sized and small companies that may be bought for growth or bargain prices (value). Each group of stocks falls in and out of favor, although it's always difficult to predict which cadre will do well in any given year. Here's a summary of the SPIVA results:
-- The majority of active manages investing in the largest stocks failed to beat a passive index; 66% of large-stock managers lagged the benchmark (S&P 500) during the past one-year period.
-- The long-term record of the big-stock managers was worse. Over the five- and 10-year periods, 84% and 82% of large-cap managers, respectively, underperformed their benchmarks.
-- Mid-cap funds performed slightly better, although most fell behind their indexes; 57% of mid-cap managers and 72% of small-cap managers failed to beat the S&P MidCap 400® and the S&P 600® over the one-year period.
-- Of all active managers, those who focused on finding bargains in smaller companies did the best of all funds. "The majority of actively managed value funds in the mid- and small-cap categories fared better than their benchmarks. The opposite can be seen with the growth funds, which underperformed their benchmarks."
-- For managers specializing in non-U.S. stocks, the picture wasn't much better. "Over the 10-year investment horizon, however, managers across all international equity categories underperformed their benchmarks."
-- The single-worst category for active investing was long-term government bond funds. Some 95% of funds didn't beat their benchmarks over the past decade.
How do you read these returns? You may have a slight advantage if you can find a manager who's adept at finding bargains in mid- and small-sized companies. But the rub here is that you need to find a fund that performs consistently well. You can't predict how well they're going to do based on their past results.
The more sensible approach -- one that's likely to produce the highest returns -- is to invest across the board in all sizes of companies and mixing value and growth stocks. To do that, you'll need a total market index fund that covers most U.S. and foreign stocks. A total bond market index is essential for your fixed-income allocation.
If your retirement plan doesn't offer such a fund, ask for one. Every mutual fund company offers one, so it's just a matter of adding one to your 401(k) mix.
