The Bull$hit Narratives Wall Street Uses To Sell You Crap Investments

If you don't know your facts, you become an easy mark

What makes passively managed index funds an amazing tool for investors—also makes selling them a lousy business for Wall Street; their ultra-low fees.

Vangaurd’s S&P 500 index ETF has an annual fee of 0.03%. If you had a $1 million portfolio, you would only pay $300 per year in fees.

It’s such a good deal that you wonder how Vanguard makes money. It works for them because they manage north of $7 trillion. Other investment firms can only dream of that kind of scale, and since they can’t compete with Vanguard on fees, they try to market actively managed funds at a higher fee.

To justify the higher fees, they promise to outperform the index funds. Anyone who has looked at the data knows they rarely do—Over the past 15 years, 93.4% of active fund managers in the U.S. have underperformed the S&P 500.

With all the evidence out there in favor of index funds, I often wonder why people still buy high-fee active funds?

In this article, I review research that reveals how informed the average Investor is and how that plays into the hands of the financial services industry.

Straight from the horse’s mouth

A survey conducted by (Choi, Robertson 2020) asked 1,013 retail investors in the U.S. what drove their decisions on how to invest their money. One of the issues they asked about was the decision to invest in actively managed mutual funds despite the evidence they typically underperform index funds.

Investors hold many false beliefs, making it easy for Wall Street to sell crappy, high-fee investment products.

The study found that investors who invested in actively managed equity mutual funds were more likely to believe that active management could deliver higher returns than passive management.

This is a classic case of the endowment effect, which is when you overvalue something that you own. If you’re already invested in an active fund, you’re less likely to be swayed by the evidence of index funds outperforming.

Many investors surveyed mentioned that they invest in active funds because they expect actively managed funds to deliver higher returns when the market is performing poorly.

While it is undeniable that index funds outperform in the long run, there is a theory—one that Wall Street uses as a sales tactic—that active managers can “protect your downside” in a bear market. But, you need only look at the COVID-19 market crash—where active managers significantly underperformed to understand that’s not always true.

Here’s the most revealing data point. The Investors surveyed believed that positive past returns of active managers was evidence of skill, leading to a belief that they could consistently outperform passive funds.

This (false) belief is how Wall Street Bull$hits people.

When a financial salesperson is selling you a high-fee investment, they show you a bunch of charts and graphs showing you how amazing the fund has performed in the past.

Of course, if you read the fine print, you’ll see the legally required disclosure, to tell the truth that past returns tell us nothing about future returns. They don’t outright lie and tell you that a fund's past returns indicate strong future performance—They just heavily imply it.

Another false belief investors have is that active managers can continue outperforming no matter how much money they have under management. There is strong evidence that the opposite is true—even if an active manager found a strategy to beat the market consistently, they can’t replicate that strategy with huge sums of money.

That means the precious few managers who can beat the market probably won’t take you on as a client.

When I think about active funds, I am reminded of this fantastic quote from Groucho Marx:

“I don't want to belong to any club that would accept me as one of its members”

Telling people the truth can change their minds—at least a little bit

Clearly, investors have a lot of misconceptions about investing.

But, as I have written about in the past, there is evidence that when presented with the facts about the outperformance of index funds, more investors are willing to move their money out of active funds.

A 2022 paper titled “Misperceived Returns to Active Investing” found that when investors were presented with evidence of why and by how much passive index funds outperform active investment funds, they were 18% more likely to believe index funds would outperform in the future.

Beliefs are one thing, but actions are more important. The most hopeful finding from that paper was that four months after the study, participants who received financial education about index funds increased their investment in index funds by 37% compared to the control group.

Telling investors the truth nudges them in the direction of index investing.

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Want to learn more about investing?

Here are three resources:

1. Every article I have written about investing

2. My book, The Investor’s Mindset

3. A crash course on index investing

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This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.