Despite what almost every fund manager in the country will tell you, it's hard to outperform the S&P/ASX 200 Index (ASX: XJO).
That's why most active fund managers, despite the handsome management fees and salaries they attract, struggle to beat the market over a long period of time.
And what's more, those that do manage it in a given year will most likely not manage it again the year after.
According to reporting in the Australian Financial Review (AFR), 87% of fund managers failed to beat the ASX 200 in performance in 2018. That's a staggering statistic.
Of course, a large part of this underperformance comes down to fees. An ASX 200 index fund like the iShares Core S&P/ASX 200 ETF (ASX: IOZ) typically charges minuscule management fees (0.09% per annum in IOZ's case). In contrast, it's not uncommon for a managed fund to charge a management fee 10 or 20 times that.
If a managed fund has a fee of 1.5%, it needs to beat the market by 1.5% every year just to break even for you. That's a tall order and (according to the AFR) one most managed funds don't measure up to.
Is it possible to beat the ASX 200 index?
Beating the index is challenging because of how efficiently the index operates. It buys more of rising companies and kicks the underperformers out.
Just think of CSL Limited (ASX: CSL). CSL is the largest share on the ASX 200 with a share price of $286.66 (at the time of writing) and an ASX 200 weighting of around 8.2%. But 5 years ago, this was a $90 stock. As CSL climbed, an ASX 200 index fund would have been continually adding to CSL's position – in other words, buying into a winner.
And without any of its investors lifting a finger. The process is automatic, with no room for human error. It's this simplicity that makes index funds so formidable.
Now, we Fools think it is possible for ordinary investors to outperform the index. Not paying usurious fees to fund managers is one place to start.
But on top of this, you have to do a lot of research and work, find companies that are real winners and buy them at great prices – preferably when no one else wants to touch them. That's partly how the great Warren Buffett managed to beat the market over multiple decades.
Beating the market is tough. But it is possible, and it's also a highly lucrative pathway to wealth creation if you can find it and stay on it.
And if you decide it's a path you don't want to tread, there's nothing wrong with sticking with an index fund either!
