Standard & Poor’s, the firm that runs the stock index behind the Thrift Savings Plan’s C Fund and does lots of independent investment research, recently released its Standard & Poor’s Indices Versus Active Funds Scorecard – SPIVA, for short – for 2008. This report compares how investors have fared with investments in actively managed mutual funds versus investments in broad, predominantly unmanaged groups of securities, or indices. In this case, the comparison is between the actively managed funds and the closest matching Standard & Poor’s or other specified index.

The idea is to measure whether managers of the actively managed funds have, in aggregate, earned their money and produced results for their investors that are superior to what could have been earned by investing in an index fund.

A copy of the report is available by visiting www.spiva.standard and scrolling down for the 2008 report.

As in the past, the most recent results for indices are impressive. Whether you invested in stocks or bonds during 2008, you would have been better off choosing low-cost index funds, such as TSP funds, than spinning the wheel and choosing an investment manager to time the markets or pick stocks for you.

Among the key findings of the research: Over the five years ending with 2008, the index underlying the C Fund outperformed more than 70 percent of actively managed domestic large-cap stock funds. Similar results were reported for the S Fund’s index versus actively managed domestic mid- and small-cap stock funds. The I Fund’s index outperformed the majority of actively managed developed foreign market stock funds, and the index underlying the F Fund outperformed the majority of actively managed domestic bond funds.

The primary reason for the actively managed funds’ underperformance, which has been measured in study after study in year after year, is expenses. It’s no coincidence that, over the long run, manager underperformance, in aggregate, tends to mirror the expense ratios charged by the funds.

As John Bogle, founder of Vanguard Funds, has explained, the performance of a market – in this case represented by various indices – is the total of the returns earned by the participants in that market. Some investors in a market will beat the average in a given period, but at the same time, another must fall short. In the end, the market’s performance is the weighted average of the participants’ results.

The problem is that before these results are passed on to investors, fees and expenses are deducted. While the average return of all investment managers equals the market average, the average return realized by their investors is this average less the cost of investing. The investors are systematically biased to fail.

But, the argument usually goes, just because most investment managers don’t outperform their markets, after expenses, doesn’t mean an investor can’t win. All one has to do is to choose winning funds. While this sounds easy, it has proven to be quite difficult. Knowing which fund or manager or group of managers is going to beat their market by enough to cover their costs, and then produce some excess profit, is impossible. The best you can do is guess and hope, but as the study results show, the odds are against you. It’s a sucker’s bet.

This argument applies to those who manage their own investment accounts, as well. While plenty of companies are out there that want you to believe it’s a wise use of your time to try to beat the market by trading stocks – and generating lots of brokerage commissions – results in the real world say otherwise. You might get lucky, but, in the long run, you’re most likely to wind up about even with the market you’re trading in, less your time and sanity. In the process, you’ve added risk that you could have avoided by investing in index funds. More risk in exchange for no more return doesn’t sound too wise to me.

The SPIVA findings help explain why I’m such a big fan of the TSP. Index funds at extraordinarily low cost are the surest way to superior investment performance for most investors. As tempting as it may be to believe that there is a better way, don’t.

Written by Mike Miles
For the Federal Times
Publication June 22, 2009