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Monday, April 21, 2008

Mutual funds vs. the market

Everybody knows mutual funds don’t do any better than the markets themselves. Well, economist Dean Baker has a take on this. Since mutual funds control half of the market, they are naturally going to have a hard time beating the market. It’s akin to criticizing teachers in general because half the students are below average.

Mutual funds control close to $10 trillion in assets. The market value of corporate equities in the United States is less than $20 trillion. In other words, mutual funds control close to half of all outstanding shares of stock.
If mutual funds control half of all stock, how can they, on average, beat the market? This would be possible if the folks who controlled the other half agreed to be very stupid, but otherwise I doubt that they would consent to accept below average returns.
The basic point is very simple, if mutual funds control half the market, then their return will on average be equal to the market return. An investor may get very lucky and find a fund managed by a Warren Buffet type, but most investors cannot possibly be so lucky. If you can assume that your fund will get the same return on its holdings as the market as a whole, then the best way to maximize returns is to find a fund with low administrative expenses.

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