According to Dave Ramsey, in a YouTube video titled: Mutual Funds vs. Market Index Funds the two most important factors for financial success are: first you must invest, and secondly what Rate of Return (ROR) you earn.
Inicisic has established and documented that Dave Ramsey’s advice is predicated on earning a 12% ROR every year of your life. The concept of being able to achieve a ROR at this level is supported by the fact that the S&P 500 has “averaged” roughly a 12% ROR since the late 1920s.
In reality, there have been many decades since the 1920s where a systematic investor could not have achieved an actual 12% ROR with results generated from investing in the S&P 500. In order to achieve an actual 12% ROR during these time frames, it would have been necessary to be invested somewhere that “beat” the S&P 500. Knowing this, it becomes necessary to pass off a reason for someone not achieving a 12% ROR, because they were not invested in the right place. It is an easy way of “passing the buck”. By doing so it is not necessary to acknowledge that earning a 12% ROR every year may not be feasible, and is therefore an assumption that should not be used as a base for financial plans. It is a way of deflecting in an unsuspicious way.
Using the video sited above, here is what Dave has to say. “A large number of mutual funds under perform the market. But there are plenty of them that over perform, that outperform the market…”
We turn to research, to either validate or disprove the theory that it is probable to outperform, ‘beat’ the market. According to a piece produced by Dimensional Funds, titled; Performance of DFA vs. Industry, with data over 20 years ending on 12/31/2019, of the 4,601 equity and fixed income mutual funds analyzed, only 782 beat their benchmark. That means that less than 17% of the funds outperformed “their market”. We must ask, does this qualify as ‘plenty’?
What is also interesting is that only 41% of the 4,601 mutual funds even survived the 20 year period. One of the reasons a mutual fund does not survive is mutual fund companies transition them to hide poor performance.
A well respected author who has done a terrific job of gathering and summarizing research, which backs the fact that a money manager is unlikely “to beat” the market over long periods of time, is Daniel R. Solin. In his book titled; The Smartest Investment Book You’ll Ever Read, he has this to say; “…in excess of 90% of actively managed mutual funds fail to equal or beat their benchmark indexes over the long term.” So, if you are depending on a mutual fund beating the market so you can earn a 12% ROR every year, the odds are not in your favor.
In the book, Mr. Solin gets a little closer to home. He sites research conducted by Ph.D., Edward S. O’Neal regarding large cap stocks. The S&P 500 is made up of ‘large cap’ stocks, the benchmark which Mr. Ramsey uses to justify a 12% ROR being feasible. Mr. O’Neal studied just two five year periods (7/93-6/98 & 7/98-6/03), from which we can glean other important information. When these two time frames were combined, only 2% of funds beat the market. If you think there is justification that you aren’t succeeding with ROR just because you have the wrong mutual fund perhaps you are asking the wrong question ‘Am I invested in the right mutual fund?’.
Instead, I would suggest you ask this question: ‘Should ROR be my primary focus?’ I would tell you it is a much safer bet to focus on efficiencies first. Why? Efficiencies are something you can count on. If a 12% Rate of Return assumption is not realistic, and therefore cannot be counted on to achieve financial success, why would any plan based on Rates of Return be dependable? Build a financial plan based on efficiencies, through coordination, and you will be able to achieve financial well-being while taking less risk.
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