Index Funds Out-performance Continues

Low cost index funds outperform market averages.

The chart below compares the returns of all US stock funds and the Vanguard Total Market fund as of 11/17/06.

Other things to consider:

Survivorship Bias
The 3, 5 and 10 year annual returns for "all" mutual funds are actually overstated. Each year between 3% and 15% of funds go out of existence (end and return money to investors or merge into another fund). These are typically the lower performing funds (otherwise why would they go out of business) that if included would bring the average down and make the relative performance of the index funds even better.

Tax Consequences
Most of the funds in the average are actively managed with higher turnover than index funds. Turnover causes short and long term capital gains and their associated tax consequences.

The chart below conservatively estimates the impact of survivorship bias and taxes and compares the returns.

The results are similar when comparing all of the international stock funds with the Vanguard Interantional stock fund index (VGTSX) below:

What effects the price of a stock?

Did you ever hear a "stock pickers" rational for picking a stock?

Have you heard the "efficient market theorists" say you can get the same (or better results) by throwing darts at a newspaper?

Well, the reality is closer to the dart thrower's version, but not because the markets are efficient - because the future is unpredictable.

Below is a list of just of few of the risk factors that will determine a stock's future price. How many of them do you think are predictable?

  • Market trends
  • Industry trends
  • Political events
  • Business issues
  • Technological changes
  • Geological (i.e. earthquakes)
  • Weather (hurricanes, cold or heat spells)
  • Cost of energy
  • Product
  • Materials
  • Management error or bad decisions
  • Competition from traditional or non-traditional sources
  • Interest rates
  • Inflation rates
  • Value/obsolescence of inventory
  • Condition of manufacturing equipment
  • Value of buildings and land
  • Access to and cost of insurance
  • Theft or dishonesty
  • Regulations by government
  • Political risks
  • Currency risks
  • Labor shortage and relations
  • Stockholder activists (proxy)
  • Brand erosion
  • Consumer fads
  • Credit ratings
  • Winning new or losing existing customers

The quatifiable stuff - discounted cash flows and dividend discount models, liquidation value, going concern value - those are easy, but provide just a portion of the information you need.