Can investors reliably pick mutual funds which beat the market?

I am a very big fan of index funds. However, I often hear the argument from my friends and relatives that index investors are content to be “average” and that smart investors who are well informed and willing to put in a little extra work should be able to “beat the market”.

If only it were that easy! There are numerous academic studies showing that, after fees, the average active mutual fund underperforms low cost index funds. These studies also show that there is very little “persistence” among the mutual funds that have managed to beat the indexes in the past. In other words, we can’t accurately predict which funds which will beat the market in the future by looking at past performance.

Despite all the evidence in favor of index funds, I find that it is very difficult to change the mind of a diehard believer in active management. Instead, I choose to stress the importance of carefully measuring investment performance. I strongly believe that any investor who does not carefully measure and evaluate investment performance is not a serious investor!  I have found that most investors who carefully and honestly monitor the performance of their investments and compare this performance to a relevant benchmark will eventually convince themselves that indexing is the way to go. Continue reading »