"Yesterday's winners, tomorrow's losers"

In an article on passive vs. active approaches to mutual-fund investing, the Wall Street Journal quotes Vanguard founder (and passive indexing guru) John Bogle on what is perhaps the biggest challenge facing active investors: "Yesterday's winners," said Bogle, "are far more likely to be tomorrow's losers."

In other words, many actively managed funds are loaded up with stocks that did well in the past (that's why managers bought them) but that are in the process of becoming underperformers. Active managers are constantly playing a game of "move ahead, then fall behind" - which generates expenses, but not much to show in terms of actual profits in comparison with low-cost indexing.

Two observations: 1) Bogle is right - this is the general case with active management; 2) Nonetheless, many actively managed funds have runs of outperformance that can stretch for many months (even years in rare cases).

Identifying these outperforming funds and investing in them until their success begins to falter is the essence of our Upgrading strategy. Upgrading isn't perfect, but that's okay. There is no perfect strategy. What Upgrading has been able to do is generate annual returns that have strongly outperformed indexing in recent years (although not every year; as noted in our just-released February issue, indexing eclipsed Upgrading ever-so-slightly in 2009).

We're all for indexing for those investors who want to follow that approach - and we're thankful that Mr. Bogle's Vanguard firm offers a terrific mix of index funds that we use for our Just-the-Basics indexing strategy. But we're also glad that Upgrading offers a way to meet the "yesterday's winners, tomorrow's losers" challenge and (usually) come out ahead.
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Matthew Pryor in his 8th year with Sound Mind Investing, now serving as Director of Operations. Visit www.soundmindinvesting.com to learn more.