Your Investment’s “Survival Rate” And Why It Matters To You
Pretend for a moment that you have a mild medical condition and you visit your doctor for advice. After looking you over and running tests, the doctor provides you with a recommendation. There is a new drug available, and she would like to prescribe it to you. The only issue is that there is a 50% chance of survival over the next 15 years. Would you take that advice?
Would you be surprised to know that there is a similar chance of survival with investments? The mutual fund/ETF industry is continually creating new products for the investor. Some of them, like the ones that we use at Waypoint, are intended to benefit the investor with lower than average costs, more tax efficiency than many others, and a very high chance that they’re built to last. Unfortunately for many, many other investments the goal is to make money off of you rather than for you.
At Waypoint, each of us has witnessed those investments come and go over the years. Whether it is the ‘high flyer’ that makes a lot of money in a short while and then busts, or the lesser-known name that has good intentions but just can’t withstand the forces against them when trying to beat the markets; we have watched innocent investors get caught up in the wake.
This is one of the big reasons we have come to rely on what we call “evidence-based” investing. It is to lead us around the misguided strategies that can otherwise cause an investor’s expected returns to be reduced over time.
How Often Do Funds Go Under?
As mentioned, in the competitive capital markets in which we operate, fund managers launch new products and discontinue existing ones all the time. The biggest reason that so many funds don’t last over longer periods of time is due to underperformance, and funds probably disappear far more frequently than you might think:
- A recent S&P Dow Jones Indices analysis found that, for the five-year period ending in December 2015, “nearly 23% of domestic equity funds, 22% of global/international equity funds, and 17% of fixed income funds have been merged or liquidated.”
- As might be expected, the longer the timeframe, the higher that “death rate”. A January 2013 Vanguard analysis of survivorship bias looked at a 15-year, 1997–2011 sample of funds identified by Morningstar. The analysis found that 46 percent “were either liquidated or merged, in some cases more than once.”
- A May 2015 Pensions & Investments (P&I) article reported that Exchange-Traded Products (including ETFs) weren’t immune from the phenomenon either, having just reached the milestone of 500 products closed. According to the “ETF Deathwatch” cited source, this represented a mortality rate of just under 23 percent.
- The same P&I piece cited Dimensional Fund Advisors and Vanguard analyses that estimated 15-year mortality rates for traditional U.S. mutual funds in the range of a 50/50 coin flip, or worse.
- A November 2015 article by financial columnist Scott Burns found similar survival rates for the 15-year period ending in 2014. “At the beginning of the period, there were 2,711 funds,” he reported. “At the end of the period, there were 1,139. Only 42 percent of the starting funds had survived.”
Why Does This Matter To You?
Why should you care about funds that no longer exist? When a fund has a low chance of surviving, it harms the investor with lower returns and potentially higher tax costs. It is more evidence that with investing, we would prefer to stack the odds in our favor as much as we can. One way that our firm does this is by investing with Dimensional Fund Advisors. While past performance is no guarantee of future results, 100% of their funds that started fifteen years ago are still around today (and 86% of those funds have outperformed their respective benchmarks).
Just as you probably wouldn’t take the doctor’s advice for a mild medical condition when given a lower than 50% chance of survival, why would you do so with your investments? We should steer clear of those investments and advisors that base their skills on their own personal knowledge of what will happen in the future. That strategy may work occasionally over short periods of time. But in the long term, and with the odds so strongly against them, why would you even take that chance?
Past performance is no guarantee of future results. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial advisor and/or tax professional before implementing any strategy discussed on this or any other newsletter.
1. Aye M. Soe, CFA, “SPIVA® U.S. Scorecard, Year-End 2015,” S&P Dow Jones Indices. Page 2.
2. “The mutual fund graveyard: An analysis of dead funds,” The Vanguard Group, January 2013. Page 3.
3. Ari I. Weinberg, “Learning from a walk through the fund graveyard,” Pensions & Investments, May 28, 2015.
4. Ron Rowland, “500 ETF Closures,” Invest With an Edge, May 19, 2015.
5. Weinberg, Pensions & Investments, May 28, 2015.
6. Scott Burns, “The missing bullet holes problem,” The Dallas Morning News, November 13, 2015.