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Proof? You Want Proof? You Can’t Handle the Proof!!!

April 20, 2017

There should be no question in anyone’s mind that I prefer index funds over so-called actively managed mutual funds. I am also leery of bond funds. Here is some “proof” of the efficacy of index funds and owning individual bonds over a long-term period.

Barron’s April 10, 2017 Mutual Fund section shows the quarterly, 1 year, 5 year and 10 year annualized returns. I address here the 5 and 10 year results which did not do better than the S&P 500 Index for any of the four large cap sectors they reported on. Additionally, while the S&P 500 measures large cap and there are separate indexes for mid, multi and small cap stocks, none of the nine sectors in those categories outperformed this index for the last 5 years nor did six of the nine for the last 10 years.

This to me is clear that the index funds were a better choice – certainly over the last 10 years. To be fair, many of the differences were small, however, people invest in the active funds because they want to beat the index – not mimic it. I believe this shows reasonable “proof” of the advisability of the index funds over actively managed funds.

These next comments address fixed income funds. The 5 year and 10 year annualized returns show that the three short term U.S. Government bond funds all averaged less than 1 percent for 5 years and the 10 year yields were about 2 percent for the three funds. Buying 1 or 2-year bank CDs and continuously rolling them over would have provided a greater return. Ditto for the Intermediate term funds. A slightly more sophisticated strategy would have been to set up a CD ladder and that would have even done better.

The long term corporate general bond funds with returns of 4.18 and 5.41 for 5 and 10 years, and the high yield funds with 5.57 and 5.89 did better than CDs would have done, but all the other bond fund categories in the Barron’s chart did not. The method I suggested in previous blogs was to buy individual bonds for longer terms, “clip” the coupons and forget about the volatility, I believe, would have done better than these funds. For your information, a 5-year CD 10 years ago was paying 4.8% and 5 years ago 2.0%. A 10-year Treasury bond was paying 4.71% with corporates about a point higher. My “buy and hold” bond strategy would have even outperformed the high yield funds. Further the average funds category means that as many funds did worse as did better. What are the chances you would only have picked the better funds or even the average ones? If you want chances, buy a lottery ticket. If you want security and dependable cash flow, buy bank CDs or a basket of longer term corporate bonds. A viable choice is also fixed annuities for upwards of five to ten years.

There is a lot more that I can say, but for now, I believe I provided enough “proof” for you to question your current strategies and if you have an investment manager, print this blog and ask him or her to critique it and compare to your current portfolio. If they say anything significantly different than what I wrote here, I would appreciate you letting me know. Here is the “proof.” How you handle it is up to you.

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