Ibbotson on Investing

The current issue of Money (September 2010) includes an interview with Roger Ibbotson (pp. 105-108). Ibbotson Associates publishes the Ibbotson SBBI Classic Yearbook which analyzes historical data for stocks, bonds, Treasury bills, and inflation. It is commonly the reference for the historical returns quoted in the financial press.

Ibbotson is a professor of finance at the Yale School of Management. He is the founder and former Chairman of Ibbotson Associates, a financial research and information firm that was acquired by Morningstar in 2006. He is also the founder, Chairman, and Chief Investment Officer for Zebra Capital, a hedge fund.

In the article, Ibbotson was asked about investing in index funds vs. actively managed funds. Here’s his response:

“To the extent you’re in index funds, you’re going to have less risk because you’re eliminating the impact of active management. You’ll also have lower fees. In actively managed funds, your risk level goes up, as will hat you pay in fees. The question is, do you think the funds you pick can compensate for the extra risk and higher fees? On average, the answer is no, but there can be a subset of investors who outperform.”

I would add there will always be some investors who choose actively managed funds and outperform the market. The issue is how long they are able to do this. Few will be able to do it consistently year after year. The question you have to ask yourself is whether you can be among them.

If you are not confident about beating the market, after expenses, then you are better off in a low-cost, passively managed portfolio. You will not beat the market. You will earn the returns of a broadly diversified portfolio. Your investing expenses will be a fraction of the typical actively managed fund.

If you review Dalbar’s research on investor performance results, you’ll find that if you achieve “average” results, you’ll be doing much better than the vast majority of investors, including large institutional managers.