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Does the “Lost Decade” Signal the End of Passive Investing?

January 05
15:03 2010

For those who can’t count, we just ended what The Wall Street Journal has, for almost two years now, called “The Lost Decade” (“Stocks Tarnished By ‘Lost Decade,’” The Wall Street Journal, March 28, 2008). With the December 31st 1037486_67672803_decay_down_royalty_free_stock_xchng_300 figures finally in, we can now officially declare the “aughts” as “The Lost Decade.” Of course, we merely join the media chorus in doing so (see “What can investors learn from a dreary decade?, January 5, 2010 and “For Rebuilt Markets, a Test in 2010,” The Wall Street Journal, January 5, 2010).

All the major indexes posted negative performance for the ten-year period ending December 31, 2009. The Dow Jones Industrial Average faired the best, losing only 9.3%, but the S&P 500 – a more widely used benchmark – fell an amazing 24.1%. And let’s not even talk about the Nasdaq Composite, which dropped 44.2% (all numbers per The Wall Street Journal).

Clearly, these awful returns mean investors should have shunned equities during the century’s first decade. Or do they? A closer examination reveals a surprising conclusion, one that might upset the fastest growing segment of the financial industry.

The Wall Street Journal publishes mutual fund rankings on a daily basis (primarily through its web-site The base data comes from Lipper, the oldest and most comprehensive mutual fund data collection and rating company. The table below shows the average annual return in each mutual fund category for the 10-year period ending December 31, 2009.


Compare the above to the average annual return of the S&P 500 of -1.00% and we can conclude investors who chose the passive route were more likely to lose money than those who chose actively managed funds. In ten out of the 12 categories, the average mutual fund beat the S&P 500. And remember, the mutual fund data already includes fees and commissions while the raw index return does not, so the real results might be even worse for passive investors.

As a percentage of total mutual fund assets, index funds have nearly doubled their market share over the last decade, exposing many more investors to an investment style the record shows woefully underperformed its competition.

Does this data signal the death knell of passive investing?

That might be a premature conclusion. For one thing, the Lipper data above contains a survivor bias. A survivor bias means the data does not include funds which closed during the ten-year period. Theoretically, one only closes poorer performing funds, so the actual mutual fund return data might be worse than what’s reflected. Of course, by closing a poorer performing fund, the investor now has a chance to invest in a better performing fund. As a result, actual investor returns may actually look better than shown here. A simple academic test (left to those in academia, of course), can answer this question.

More importantly, though, any data analysis that ends with a singular date can (and often does) suffer from the “Snapshot-in-Time-Anomaly.” This anomaly represents a form of a statistical artifact behavioral psychology calls “recency” – the tendency to overweight near-term results. Fortunately, at least one previous study (“The Emperor Exposed,” Journal of Financial Planning, October 2005), already provides the academic review that mitigates the Snapshot-in-Time-Anomaly. Both that study and its unpublished update imply neither active nor passive investment styles supersede the other (although there was a slightly greater statistical chance that active would outperform passive). In the end, the most accurate headline on this topic might have been “Has Active Or Passive Outperformed? It Depends,” (Financial Advisor, August 2009).

While all this analysis might overburden the typical 401k fiduciary, one practical due diligence result does surface. While offering a mix of both active and passive investment options probably rises as the most prudent choice, clearly an array of average passive-only choices has the potential to create more liability than a menu of average active-only mutual funds.

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About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA


  1. Roger Wohlner
    Roger Wohlner January 08, 11:53

    Good article, excellent points regarding both the “Snapshot-in-Time-Anomaly” and the survivorship bias. For still another perspective on the “Lost Decade” check out this NYT article by Ron Lieber

  2. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author January 08, 14:07

    Thanks for the comment Roger.

    The New York Times article alludes to the “Snapshot-in-Time” Anomaly, although not by name. The author’s data is correct, but he’s more correct than he writes. Investors didn’t need to allocate among indexes as he suggests. According to the Lipper data, it was probably easier than that.

    I’d really like to see some behavioral research done on this past decade to see how investors really did.

  3. Bert Livingston
    Bert Livingston January 19, 09:49

    After 31 years in this business I am always amazed at the way people “measure” success and failure in relation to “returns”…who cares which Index or measuring stick is used? The client needs to succeed on his/her terms and there is no artificial time frame available that can determine what the client needs. Ten year has become the media calling card…”lost decade” is a media driven term. When did we start using 10 years as a mile post anyway? Only when it looked like a “first time event” where the vaunted S&P 500 failed to meet expectations…well take a look around you, managed mutual funds at a number of major fund families returned 2.85% to 10% per year on stock funds, net of those terrible management fees over that 10 year time frame…all those who were mislead by Vanguard elite are now caught in a squeeze…stay with the Index or move to diversification. “Snapshot in time anomaly” I could not agree more…it happens at the top and the bottom…and even in between. No surprise here, my clients did not experience a lost decade. BERT

  4. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author January 19, 11:08

    Bert, thanks for enjoying this article. From the comments of others – both here and on LinkedIn, I think many others agree with you.

  5. David Middleton
    David Middleton August 18, 15:56

    Interesting article, Mr. Carosa, but I’m not convinced. The S&P500 is primarily a large cap index that represents a blend between value and growth stocks. Therefore, the only meaningful Lipper stats are

    LCV mutual fund 10yr avg annual return:2.04%
    LCG mutual fund 10yr avg annual return: -2.91%

    SP500 10yr avg annual return: -1.00%

    So, net out the LCV and LCG assuming the SP500 is 50% value and 50% growth (actual percentages are always changing) and what do you get? 2.04-2.91= -0.87%. Factor in the survivor bias you mentioned and the LCV/LCG mutual fund average is essentially minus1.00%, matching the index.

    Therefore, why would I take the chance on an expensive active manager that might be one of the severe under-performers? I’m certainly not persuaded that, as you say, “…an array of average passive-only choices has the potential to create more liability than a menu of average active-only mutual funds.” There might be arguments for that, but not based on historical returns.

    I’m not a die hard indexer, but the data doesn’t support your claim, in my opinion.

    Thanks for the article.

  6. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author August 18, 16:03

    David, thanks for your comment. I’ll ask you to reread the article regarding my emphasis of the S&P 500. In fact, as the piece implies, it was the best performing index for the period. Also, I don’t think you can simply add together statistics the way you did. You’d need to use the weighted average, which is not provided in the above table. You’d need to look at the Large Cap Core if you want to compare to a portfolio that contains a blend of large cap growth and value securities, and that did out perform the S&P.

  7. R. Stanley
    R. Stanley May 08, 18:28

    Funny, you fail to mention the article “The Emperor Exposed,” Journal of Financial Planning, October 2005 was retracted by the Journal when it was challenged in the fall 2005 and remains so. We won’t even go into the controversy around the historic data supposedly used in the study which mysteriously couldn’t be found nor duplicated.

    As to your article, the comment above by David is basically correct, although he fails to point out the classic “apples to oranges” comparison error. The S&P500 index is not the correct index to use when evaluating the above outcomes. Indexes, including investable index funds, exist for each of the size/style categories listed above including S&P indexes for each listed category. A fiduciary who advises in this field had best know that and use those indexes when making performance evaluations and outcome comparisons lest he wants to become liable for misleading and/or misinforming his patrons.

    In fact perhaps this article should be retracted, you can never tell about that liability thing after all.

    R. Stanley

  8. Mike Finley
    Mike Finley May 03, 08:41

    This is a poorly written article and I am betting it has nothing to do with your lack of financial education. Comparing the S & P 500 with those other indexes is utterly ridiculous. How did indexing do in relation to the managed funds that replicated that particular index over that time period? Let me help you with that, it soundly beat the majority of managed funds, which it did the previous decade and the one before that. The other indexes beat their managed funds as well. Something you failed to mention in this hit piece. Also, commissions are not accounted for as you say. Anyone who knows anything about the business knows that there are multiple loads placed along the way (A, B, and C for example) and no analysis could attempt to replicate what the average person would experience. John Bogle is correct in his analysis as he continues to fight for the average person. You and your ilk are the problem, not the solution. Shame on you.

  9. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author May 03, 12:47

    Mike. Please read related articles on this site to address your questions. The fact is that neither actively managed nor passively managed portfolios consistently beat the other. The article highlights this notion by focused on an entire decade where passive, contrary to popular belief, failed to beat actively managed funds. When you take commissions into account, then academic research shows there’s no statistical difference between the index (i.e., not an index fund, which depending on its own commission structure, can often underperform the index) and no-load mutual funds. In fact, when I talk to current generation of academic researchers, they are well beyond the assumption that passive beats active. In fact, they’re focus is on the behavioral anomalies that cause passive to underperform active in certain periods. Again, I encourage all readers to read all the literature on this. Both styles have their merits, but there’s no evidence one will always outperform the other.

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