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Actively managed funds are a bad idea

·2 mins

I recently got interested in a few actively managed mutual funds from Morgan Stanley. They had high expense ratio and turnover rate but I thought, if their stellar performance continued from 2020, the extra costs would be worth it. However, that wasn’t the right way to think about it.

  • While cliched, it is true that past performance doesn’t gurantee future results.
    • I also don’t control or understand the factors that go into stock selection behind the scenes - I can only trust the fund managers.
    • CPOAX, for instance, had a really good 2020 but, when I looked back for 2 year time frames, it rarely outperformed VTSAX. I shouldn’t be blindsided by a single year’s performance, that too 2020 when the whole market was exuberant.
  • There is plenty of historical evidence that actively managed funds never consistently outperform the index, if at all. So, even if the fund I selected is outperforming today, I have another headache of figuring out when to get out.
  • They aren’t well diversified. For e.g., CPOAX only contains <50 stocks, most of them large cap.
    • If I try to compensate for that myself (for e.g., by buying Morgan Stanley’s MACGX for mid-cap companies), that will complicate things further.
  • Highly tax inefficient, if kept in taxable accounts.
  • High costs add up in the long run.

I think I should do the following:

  • Put majority of my money in index funds such as VTSAX or VTWAX.
    • Also, don’t worry about timing the market. If I sell company RSUs, just move all the cash to one of these funds in one go.
  • If I want to increase my risk exposure, simply find out the top 10 holdings of an actively-managed mutual funds I like and buy those individual stocks. I can then rebalance once a quarter or two.