As I entered true adulthood back in the 1980s, I was immersed in the Myth of Magellan, based on the performance of the mutual fund of the same name and the Peter (Lynch) Parable, “One Up on Wall Street.” This best selling book (and others that followed) perpetuated the myth that mutual fund managers were capable of “Beating the Street” (the title of his second book). It was because of the success of Lynch’s Fidelity Magellan fund that I accepted the conventional wisdom of the day; a smart manager can beat the market.
I spent the next few years searching for the next Peter Lynch. Year after year, the previous best managers somehow lost their touch in subsequent periods. I began to question the wisdom of seeking superior active mutual fund managers. What was the option? Index funds? Weren’t they nothing more than just average? Wasn’t settling for and suggesting mediocrity an admission of Wall Street’s (and my own) failure?
In fact, it was. By the dawn of the new century, I was reaching the conclusion that I might have been wrong for many years. Active management didn’t seem to be effective. The more I learned, the more I grew concerned. I bore a healthy distrust for most of mainstream Wall Street (the banks and brokerage firms). I hated sales commissions and high fees. I saw first hand the unscrupulous methods that Wall Street used to disguise the real cost of its “advice.”
Were all of these big, no-load investing firms perpetuating their own form of investor deception? Was successful active fund management a reasonable expectation? Had I sought out the most obvious answers (obvious only in hindsight), I would have realized the error of my assumptions.
Active management requires that managers consistently pick winners and sell losers. That requires some ability to predict the future. Since no one can know something that is unknowable (the future), we are left making educated guesses.
To improve the quality of their guesses managers attempt to identify factors that might influence a stock’s price. This in-depth research costs money, raising fund expenses.
To justify an extra 1% annual management fee, a fund would have to find a way to add more than 1% extra return over a comparable unmanaged portfolio. The more I learned, the less I believed that active managers could add enough extra return to justify their cost.
As the volume of research refuting the Myth of Magellan grew massively, I quickly realized that it was almost impossible to outperform passive investing. I became convinced that investors were better off paying less to own the whole global economy and rebalancing. My education overcame a powerfully persuasive myth.
So, why do the majority of investors continue to believe the Myth of Magellan? Columnist and author, Larry Swedroe, believes that a lack of education is a big part of the problem.
I know that education led me to realize the error of my ways. Apparently it also convinced the father of the Myth of Magellan, Peter Lynch that, despite his past success, he was mistaken about the power of active management. In John Bogle’s “Little Book of Common Sense Investing” Lynch stated “…the deterioration by professionals is getting worse. The public would be better off in an index fund.”
The truth is a difficult thing to deny.