When Average Isn't Average

by Jeff C. Johnson

Stock market returns

It goes to reason that the “average” stock mutual fund would generate investment results equal to the return of a market index, such as the S&P 500 Index or the Dow Jones Industrial Average. But it’s not true.

To be very clear, the average mutual fund does not beat the market averages. In fact, statistics reveal that most mutual funds cannot beat the index* that measures their asset class.

Most large company mutual funds that are widely diversified cannot beat the well-known S&P 500. In a typical year, about one out of six mutual funds that own the large company stocks actually outperform the index. And that group of outperformers changes most years!

Well, shoot, that’s a bummer, you might say.

But is it really?

Historical long-term returns of stock indices have generated attractive returns. Why not seek market average returns for starters, then boost returns by diversifying with the asset classes of the equity market that boast the highest long-term returns?

An important point that many investors (and some advisers) never learn: Mutual funds that match the return of a stock index beat the majority of similar mutual funds.

This is where “average” is better than average.

*There are indices that measure the return of various asset classes that have different return and risk characteristics. For example, large US companies will likely have much different results than emerging markets from developing economies or from small US companies, etc. Proper measurement of stock market returns should be based on comparisons to an appropriate index. Measuring small company or international investments to the S&P 500 Index of large US companies is a faulty comparison. Likewise, comparing a well-diversified portfolio to any one index can lead to poor decision-making.