by Bob Stokes
Updated: July 15, 2016
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[Editor's Note: The text version of the story is below.]
You've probably seen them too: financial articles that tout the benefits of investing in mutual funds versus picking stocks yourself.
One often mentioned advantage is market diversity with a relatively small amount of capital. Another is access to professional money managers, for which shareholders pay a fee. Generally, these costs are significantly higher versus those for passive funds, such as the funds which track the returns of market benchmarks.
Supposedly, professional stock pickers will outperform the broad market.
But, so far this year, many investors in actively managed mutual funds have been disappointed (CNBC, July 13):
Active fund managers had their worst first half ever, with fewer than one in five beating a basic market benchmark, according to data … that go back to 2003.
Stock pickers were done in by two major factors: following the crowd and an uneven pattern of correlations among stocks.
Investors probably presume that the manager of their fund evaluates stocks independently. But we've long seen evidence that groupthink is pervasive among money managers.
Indeed, the May Elliott Wave Theorist was almost entirely about financial herding:
It is widely known that professional money managers, in the aggregate, fail to beat the market. It is not, as some theorists say, because the market is random. It is because most professionals are herding, right along with most other speculators. [The chart below] shows that at good prices for buying stock, mutual fund managers have high levels of cash, and at good prices for selling, they have low levels of cash. This record confirms that they consistently do the opposite of what they should be doing for maximum return.
I'm discussing the role of herding in the lackluster performance of most actively managed funds to make you aware of the need for independent investment thinking. This includes an objective analysis of the market's price pattern that may lead to forecasts that differ from the prevailing sentiment.
With the S&P 500 in record-high territory, this is an ideal time to learn about the important price levels we're watching so you can prepare for the next trend change we see ahead.