Ch. 6:  The Pitfalls of Active Management

Chapter 6:  The Pitfalls of Active Management

6.0 Introduction

            Imagine you are asked to compete against the greatest rock-paper-scissors player on earth.  You know the game, right?  Paper beats rock, rock beats scissors, yeah yeah yeah.  What would be your strategy?  Well, not knowing anything about your opponent (other than the fact that they are skilled), the strategy is quite simple.  Since you don’t know what your opponent will “throw”, you should recognize that each option is equally valid.  If you throw a rock, you will win one-third of the time, lose one-third, and tie one-third.  The same for paper and scissors.  The only way to be consistently beaten is if your opponent is able to predict your decision.  So, to win, you should randomly select one of the three options.  You will win one-third of the time.  Your opponent, regardless of how much training they have received, will also win one-third of the time.  And you’ll tie one-third of the time.  The ideal strategy is thusly very simple to implement.  It’s quite the paradox.  Building a winning strategy in rock-paper-scissors is so difficult that it becomes impossible.  Yet building the best possible strategy is incredibly easy.

            As I will argue, a similar argument can be made for stocks.  You could spend years studying rock-paper-scissors, but it would be a major waste of time.  Likewise, one could spend years studying the stock market, this too would be a waste of time (or worse).  Would you pay someone to help you become a great rock-paper-scissors player?   No.  Should you pay someone to help you pick stocks?  No. 

6.1 What is Active Management

            Using the example provided above, some rock-paper-scissors competitors might try to gather some data and improve their skill.  For example, imagine I found a huge database of past competitions and learned that players were “throwing” rock far more than paper or scissors.  This is an exploitable situation.  As a player, I can now throw paper at a higher frequency and increase my chances of winning.  This has some logic, right? 

  Active investors are like this type of competitor—they gather data, they look for trends, and they try to improve their abilities.  Active investing is the act of picking and choosing specific stocks (or other investments) to generate investment returns that are above and beyond what typical investors could earn.  Or to put more simply, active investors are trying to earn a return that is better than the market as a whole.  Over the last several decades, the US stock market has generated a 10% annual return.  Active investors seek to perform better than this average return. 

  Comparatively, passive investors are like the rock-paper-scissors competitors that just randomly pick one of three choices.  They don’t try to do anything special.  They don’t need data or to look at trends.  If this type of player competes against anyone in the world, they have a 50% chance of winning (ignoring ties).  They are, by design, average.  Passive investing is the act of investing in the entire stock market in an effort to earn average returns.   It’s an “if you can’t beat them, join them” philosophy.  Many choose to invest in S&P 500 Index Funds, which will mirror the performance of the index.  Or, you might invest in a total stock market index fund, which tracks the performance of the entire US stock market.  In chapter 7, we will learn all about the merits of passive investing via index funds.  But for now, let’s see why active investing fails.

6.2 Active Investing with the Help of Others (and why it fails)

            Seeking the advice of experts is usually a smart move.  If I ever try to learn how to snowboard, you bet your ass I’m at least watching a few YouTube tutorials before hitting the slopes.  Some investors will take this mentality.  Rather than picking companies in which to invest on their own, they give their money to others.  The “others” in this case could take on many forms.  Or, they might try to beat the market on their own.  Let’s explore.

Scenario 1:  Hiring a Professional

  One could hire a financial advisor or a financial planner.  While these two terms are often used interchangeably, a financial advisor would be best described as an investment specialist who chooses how to invest your money.  A financial planner is more holistic; they provide general guidance on financial choices including how to invest.  Seeking financial guidance from a professional (particularly a Certified Financial Planner) is a good idea for many, especially the financially illiterate.  And not all financial planners are trying to beat the market.  Many will choose the “average” path of index fund investing.  But, regardless of their investing mentalities, these professionals are expensive.  And they are usually bad at investing (more on that later).  I’m guessing if you are reading this book, you probably want to manage money without having to pay someone.  So, I won’t discuss financial professionals any further.  (Future Article—Financial Planning)

Scenario 2:  Using a Mutual Fund

            Alternatively, you could take a different approach and invest in a mutual fund.  A mutual fund is a collection of assets (usually stocks) that are hand-picked by a manager.  If you invest in a mutual fund, your money is pooled with hundreds of other investors and the mutual fund manager will choose how all this money is invested.  The manager tries to beat the market.  Mutual funds typically hold dozens, if not hundreds, of different stocks and maybe a smattering of other assets.  Mutual funds are also expensive, but usually cheaper than hiring an advisor or planner.

            The Growth Fund of America (AGTHX), a mutual fund issued by Capital Group is one of the largest mutual funds.  At the time of writing, the fund holds $250 Billion in invested money.  The image below provides additional information on the fund.

www.capitalgroup.com/individual/investments/fund/agthx#com_mod_jump_to_fund_modal

As indicated, the mutual fund is primarily invested in US stocks, while importantly 4.4% of the fund is held in cash.[1]  The fund primarily invests in big firms with 77% of the money invested in large-cap stocks.  The weighted average shows that your invested money will, on average, be invested in a firm with a market cap of $162 Billion.

            Jumping ahead of ourselves a bit, let’s see how this mutual fund has performed.  At the time of writing…  If you invested $10,000 in this fund ten years ago, you would now have $20,288.  If you have, instead, invested $10,000 in the S&P 500, you would have $22,958.  You can get updated figures at the link shared in the footnote to this sentence.[2]  The performance of one mutual fund against a benchmark doesn’t mean much.  But this is typical.  The vast majority of mutual funds not only fail to beat the market, they underperform drastically over long time horizons.

Scenario 3:  All by myself

            Or, you could take full control and pick and choose stocks on your own.  This is the choice that a lot of young investors make.  You probably have friends that spend time watching financial news shows, reading investment blogs, digesting posts from reddit.com/r/wallstreetbets and the like.  Maybe some beat the market, but most don’t.  A lot of these investors employ technical analysis, where they use trends and math concepts to build a data-driven approach to investing.  I cannot completely toss-out the viability of individual investing.  There are even some nice tax advantages that one could generate by investing in individual stocks.[3]  We will circle back on this concept in Chapter 7.  The rest of the chapter focuses primarily on mutual funds.

6.3 Why Active Investing Fails --  Fees

            Unless you are investing on your own, you will be forced to pay fees.  It is absolutely crucial that you understand fees even if you don’t plan to use a mutual fund.  Why?  Because sometimes actively managed funds are the only investment options you will have in a 401(k) plan.  Furthermore, passively managed funds also typically have fees.  So we need to understand what we are paying for! 

Fee #1:  Front-End Load Fees

            We will start with the most straightforward fee—front-end load fees.  A front-end load fee (sometimes generically called a “sales charge”) is a one-time investment charge that you pay when you invest in a fund.  For example, you might buy shares of a mutual fund that charges a 5.0% front-end load fee.  This means that if you invest $1,000 into the mutual fund, $50 will be collected by the fund manager upon your purchase.  Thus, only $950 of your money is truly invested.  I hate fees.  Hate them.  But at least this one is pretty straightforward and you only pay it once. 

            How will your future be adversely impacted by front-end load fees?  Let’s investigate.  Imagine you make a single $10,000 investment today in a fund that earns an annual return of 10% and charges no fee.  Your friend invests $10,000 into a similar fund that also earns a 10% annual return but is required to pay a 2.5% front-end load fee.  Where will you stand after thirty years of investing?  Well, your friend will have to pay a sales charge of $250, so they can only invest $9,750. Let’s see how you compare 30 years later.

            You:  FV = $10,000(1 + 0.1)30      =  $174,484.02

            Friend:  FV = $9,750(1 + 0.1)30 =  $170,131.67

After 30 years of investing, you have $4,352.35 more than your friend.  Your friend misses out on the compound interest that you enjoy from the extra $250 that you get to invest.  Both at the beginning and end of the investment period, your friend has 2.5% less wealth than you, but the 2.5% represents more money as time passes.

Fee #2:  Back-End Load Fees

            The sibling of front-end load fees, back-end load fees (confusingly, also known as a “sales charge” in some cases), are one-time fees that you pay when you sell shares of a mutual fund.  Since this fee is not paid until you sell shares, unsavvy investors may fail to recognize the true cost of their investments.  I’ve always felt this was a practice of deception by mutual fund managers, but that’s just my opinion… man. 

  Some non-fiction for you… a colleague of mine once showed me her portfolio, which was almost entirely invested into one mutual fund that levied a 5.25% back-end load fee.  After years of steady contributions, she held $300,000 in this costly mutual fund.  Imagine her shock when she learned that upon selling her shares, she would pay a 5.25% fee, which amounts to $15,750.  To stop the bleeding, I recommended that she sell her shares immediately and invest in something less awful.  She soon sold all her shares and bought a low-cost index fund (good move).  But the damage was done… $15,750 in wealth evaporated in the blink of an eye.  Well, I guess it didn’t evaporate.  The seedy mutual fund manager just got paid. 

  Now, let’s compare the cost of front-end load fees with back-end load fees.  First, let’s imagine that Joanna invests $100,000 in a mutual fund with a 3% front-end load fees (thus, she pays a $3,000 front-end fee).  Let’s see how much wealth she will have in 40 years, when she sells her shares.

Joanna:  FV = $97,000(1 + 0.1)40  =  $4,390,147.79

Joanna has converted her $100,000 into $4.39 million.  Let’s compare with Aiden.  Aiden also invests in a fund that generates a 10% return, but he pays a 3% back-end load fee when he sells his shares in 40 years. 

Aiden:  FV = $100,000(1 + 0.1)40  =  $4,525,925.56

3% fee upon sale:  $4,525,925.56(0.03) = $135.777.77

Remaining Funds = $4,390.147.79

Thus, 3% fees, whether levied at the front-end or back-end,  have the same impact on your finances.   Note that these investors would have $135,777.77 more had they found an otherwise similar investment with no fees.  Yikes. 

Fee #3:  Expense Ratios

            If you don’t like load-fees, you are really not going to like expense ratios.  Expense ratios are fees that are levied constantly on your mutual fund (and other investment funds).  Unlike load-fees, expense ratios are virtually unavoidable.  You will likely have no choice but to invest in funds that levy expense ratios in your 401(k), for example.  Well, that sucks, but we better learn how expense ratios work so that we can make some good choices.

            Unlike the sales charges discussed above, expense ratios are not one-time fees.  Rather, expense ratios are charged continuously on your account.  This is important.  A 1% expense ratio does not mean that you are charged a 1% fee one time.  Instead, it effectively means that 1% of your invested money will be collected by the fund manager every year.  The specifics on such fees vary, but many funds will gradually siphon money from your account so that you are, on an annual basis, forfeiting about 1% of your invested money each year to the manager.  Because the fee is paid very slowly, you may not notice the fees at all.  But, like termites, the infestation of fees will slowly, yet steadily, erode your wealth. 

            Mathematically, the effects of expense ratios can be easily demonstrated.  Let’s imagine Amaya invests $100,000 in a fund that charges a 1% expense ratio.  If their underlying investments earn no return (0% growth) during the year, Amaya’s will still be charged the 1% expense ratio.  Thus, she will end the year with $99,000.  Effectively, an expense ratio is like a negative interest rate.  A 0% return is actually a -1% return after fees.  An 8% before-fee return is realized as a 7% gain.  And so forth.  This makes the math easy and reveals the true devastation of expense ratios.  Let’s compare 30 years of Amaya’s $100,000 investment relative to an otherwise identical fund with no fees, assuming an underlying 10% return on stocks.  With a 1% expense ratio, her 10% return is effectively only a 9% return.  Using a basic FV formula, we can solve:

Amaya:  FV = $100,000(1 + 0.1 – 0.01)30  =  $1,326,767.85

No Fees:  FV = $100,000(1 + 0.1)30 =  $1,744,940.23

  Great googly moogly.  A teeny tiny little 1% fee certainly adds-up.  After thirty years, Amaya has $418K less as a result of the fees, compared to someone that pays no fees.  That’s huge!  Expense ratios are so powerful because they use the time value of money against you.  In Amaya’s first year of investing, she paid (roughly) $1,000 of fees—1% of $100,000.  But this belies the true cost.  Not only does she lose $1,000, but she also loses the return that the $1,000 would have generated!  And she pays the 1% fee every year!  

  To show the effect of expense ratios on growth, consider the table below, which indicates the future value of a $100,000 investment today, assuming an underlying return of 10%.  In other words, imagine each of the funds below generated 10% before the consideration of fees.

As indicated, the true costs of expense ratios are massive, especially when we consider long-term investing.  As we will learn in chapter 7, even the majority of passively managed funds charge expense ratios.  For example, many of the most popular S&P 500 index funds levy expense ratios of about 0.05%.  That sounds like nothing, but even this small fee leads to a four-figure difference in future wealth relative to paying no fees.

            Many of the most despicable mutual funds will charge multiple fees.  Consider the aforementioned Growth Fund of America (AGTHX) mutual fund, which has $250 billion in assets under management (current money invested).  Let’s look at this fund’s fees.

www.schwab.wallst.com/Prospect/Research/mutualfunds/fees.asp?symbol=AGTHX

How do we read this?  Well, the fund has a 0.63% expense ratio, a 5.75% front-end load fee, and a 0.24% 12b-1 fee.  A 12b-1 fee is the cost you pay just for the fund to be marketed to lure investors.  LOL.  Thankfully (and not obviously), the 0.24% is already included in the 0.63% expense ratio.  I see this daggum AGTHX fund in students’ portfolios all the time.  Last semester, I was teaching two sections of Personal Finance (35 students in each) and both classes had multiple students that had invested the majority of their entire net worth into this exact fund.  Why? Because some unscrupulous financial advisor chose this fund to earn a commission (or falsely believed the fund was magically going to beat the market).  There is a massive conflict of interest at play—advisors make the most money when you invest in expensive mutual funds.  As we will soon see, actively managed funds, on average, perform worse than index funds.  So, if you invest in a mutual fund, you are paying someone to earn a return that is worse than the average.  Sucks.

6.4 Why Active Investing Fails --  Time Out of the Market

            Actively managed funds try to beat the market.  This means they sometimes need to be “out of the market” as they sell shares of one stock to (immediately or eventually) buy shares from other corporations.  Some financial advisors and even mutual funds will actually get out of the market almost entirely under the belief that the market is due for a downturn.  But, as academic research clearly shows, financial advisors and mutual fund managers do not have any special ability to time the market.  As such, active managers that hold funds outside of the market disserve their clients.  The previously mentioned AGTX currently has 4.4% of its $250B in assets under management held in cash—that’s $11 Billion!  These $11 Billion are held in assets that are very liquid and earn little to no interest. 

            To better understand the cost of being out of the market, let’s consider the effects of holding money in cash (earning 0%) rather than in the stock market (10% return).

As indicated by the table above, the impact of holding some funds “out of the market” is far from negligible.  For example, investing $100,000 in AGTHX will result in $252,362 in funds after ten years, whereas you will have $259,374 if you have invested in a fund that fully invests in stocks.[4]   And remember, you’re paying AGTHX a 0.63% expense ratio and a 5.75% front-end load for the “privilege” of having some of your invested funds held in cash.  

            Can AGTHX beat the market?  The odds are certainly stacked against them!  To beat the market, AGTHX must outperform the market by such a massively wide margin that it overcomes its expenses and compensates for its cash holdings.  If it manages to find stocks that beat the market by, say, 0.5% every year (which would be downright miraculous), it will still earn much lower returns than an investor that buys broadly diversified index funds.

6.5 Why Active Investing Fails --  Excessive Risk

            When it comes to large sums of money, just about everyone is risk averse, this means that people prefer to take on as little risk as possible, given a desired level of return.  For example, if I strive to earn a 7% return on my investment, I would like to do so with the minimal level of risk.  Generally speaking, the best way to minimize risk is to diversify.  If you have $10,000 to invest, you could randomly select one company and spend all $10,000 on shares of this corporation.  What would be your expected return on this investment?  10%.  Since the average return of the entire stock market is 10%, the average return of each individual stock is also 10%.  However, the risk of investing in one corporation is enormous.  You could easily lose all your money (or you could get lucky and become very rich).  What about taking your $10,000 and investing across 10 different firms?  This would still generate an expected return of 10%, but now you have reduced your risk substantially. 

            So, what would be optimal if you want to generate 10% return?  Unless you have some kind of special stock market wizardry, it would be best to invest $10,000 across all corporations, probably on a value-weighted basis.[5]  If you invest in the entire market, you have diversified as much as you possibly can, while still investing entirely in stocks.

            Mutual funds must not be this diversified.  If mutual fund managers (and financial advisors, for that matter) try to pick and choose specific stocks in which to invest, they will inherently take on more risk than the market as a whole.  It’s that simple.

6.7 Mutual Fund Performance (Case Study of AGTXH)

            To close things out, let’s consider the performance of Growth Fund of America (AGTHX).  I know I keep harping on about this mutual fund, but remember it has $250 Billion in assets under management.  That’s crazy!  $250,000,000,000!  The table below displays AGTHX vs. a no-cost index fund.  This is a bit of an unfair fight as it’s not always easy to find a no-cost (or even low-cost) index fund in a 401(k), for example.  But, they certainly exist.[6]

www.schwab.wallst.com/Prospect/Research/mutualfunds/performance.asp?symbol=AGTHX

Over the last fifteen years, AGTHX has performed relatively well.  In fact, they actually beat the market by a tiny degree!  Considering their expense ratio of 0.63% and the fact that they only lagged the index by 0.28% over the fifteen-year period, AGTHX actually beat the market by 0.35% annually!  That’s kind of impressive, to be honest.

  But it gets worse.  The numbers above do not include the 5.75% front-end load fee that investors must pay to purchase shares of the mutual fund.  YIKES. 

            Some back-of-the-envelope calculations for you… If you invested $100,000 into AGTHX fifteen years ago, you would have $739,381.25 considering all fees.  If you instead invested in a no-cost S&P 500 Index Fund, you would have $813,706.16.  I hope the gravity of this is reaching you.  AGTHX actually performed better than the market for a fifteen-year period, which is extremely difficult to do, yet a $100,000 investor lost about $74,000 by choosing AGTHX instead of a no-cost index fund.  

            The image below comes directly from American’s Fund’s website.  American Fund is an investment firm that funds AGTHX and other mutual funds.  As can be seen, AGTHX was the highest performing mutual fund offered by AGTHX.  Kudos to American Funds for being honest, I guess.  You can see that AGTHX is earning a lower return than the S&P 500 and taking on more risk.  Yet there are $250 Billion worth of assets held in this fund.  The world is a crazy place.

6.8 Conclusions

            There are some mutual funds that manage to beat the market every year, and some may do so for 10 years or longer.  But, with 2,000-plus mutual funds in existence, there are bound to be some outliers.  Problematically, research shows that mutual funds that beat the market in the past are no more likely to beat the market than other mutual funds in the future.  As an individual investor, you should recognize that you are much more likely to generate strong returns if you invest in the entire market (probably via index funds) rather than by using mutual funds.  Consider the following table:

www.spglobal.com/spdji/en/documents/spiva/spiva-us-year-end-2022.pdf

As indicated, the likelihood of choosing a mutual fund that beats the market shrinks as the duration grows.  Across all US domestic funds, about 17% of actively managed mutual funds beat their respective benchmarks over a three-year period.  Over a twenty-year period, only 3% do.  Active managers do a bit better with small-cap funds, as about 8% beat the market over 20-years of investing—this means in a room of 13 active investors, one has beaten the market over 20-years. 

            Someone’s going to read this chapter and throw a hissy-fit, but I’m tired of all the pussyfooting around.  MUTUAL FUNDS AND ACTIVE MANAGEMENT SUCK!  Without question, many (most?) of these mutual fund managers know more about finance than I do, but where does it get them?  Well, it gets them to an all-inclusive resort in Cabo, fully funded by your load fees.  But how do they help you?  They don’t!  Screw these mutual fund managers.  Let’s let data and academic research be the wind behind our sails and passively manage our way to financial freedom!  Chapter 7 will tell us how.

            But, before I let you go.  One last very important parting shot to the mutual fund managers.  A point that is unassailable in my eyes.  The performance of total stock market index funds will always match the performance of the entire US stock market, right?  So passive funds perform at the average level—they must.  It must also be true that active funds, collectively, must hold stocks that perform at the average level, right?  Think about it, the entire stock market is held by active and passive investors.  If passive investors perform at the average level, then the rest of the market (active investors) must also perform at the average level.  But, active managers charge higher fees.  So, collectively, passive investors will always beat mutual funds.   Active management is a zero-sum game that will cost you money to play.

End Notes

[1] Why?  Well… the mutual fund is constantly taking in new cash from investors and also paying-out investors that are selling shares of the fund.  So, it’s practical to have some cash-on-hand.  The fund managers may also be planning to invest that money soon.  Regardless, this is bad news for investors.  If 4.4% of your money is not invested, then your returns will be lower.

[2] seekingalpha.com/symbol/AGTHX/momentum/performance

[3] Here is a nice primer to get you started:  Link.

[4] To be clear, I am assuming that AGTHX performs just as well as any other fund in this example.  If AGTHX is able to somehow “beat the market”, it could theoretically outperform a 100% stock fund.  Yeah, good luck.

[5] If you forgot what value-weighted means, flip back to chapter 4.

[6] Fidelity is my recommendation.  Link

Key Terms

Active Investing:  Investing strategy where one is trying to beat the market by investing in specific assets rather than broadly diversifying. 

Back-End Load Fee: Fee that some mutual funds (and other assets) charge investors when they sell shares of the fund. 

Benchmark:  A comparison group, for investing.  For example, if a mutual fund invests entirely in large-cap stocks, we would gage this fund’s performance relative to the S&P 500.

Expense Ratio:  Fee that some mutual funds (and other assets) charge investors continuously over time.  You better not be skipping this section of the book.  Get your ass out of the “key terms” section and go back to the full write-up. 

Financial Advisor:  A financial professional that usually is focused on investing.  You can pay a financial advisor to invest your money.

Financial Planner:  A financial professional that can help you with all aspects of personal finance.  Rather than read this book, you could hire one and that wouldn’t be an awful decision (if you can find a decent one).  But they are expensive.

Front-End Load Fee: Fee that some mutual funds (and other assets) charge investors when they buy shares of the fund. 

Mutual Fund: An actively managed fund that contains primarily stocks.  The fund manager picks and chooses specific stocks to buy in hopes of beating the market.

Passive Investing:  An investing strategy where an individual buys a broadly diversified index fund to achieve average returns.

Risk Averse:  Tendency to avoid risk.  Someone who is risk averse would rather earn $500 than have a 50/50 chance of winning $1,000 or nothing.  When large amounts of money are involved, almost everyone is risk averse.

S&P 500 Index Fund:  An index fund that tracks the performance of the S&P 500.  By investing in such a fund, you are buying shares of the 500 largest US companies on a value-weighted basis.

Technical Analysis:  Employing data, graphs, trends, etc. to build an investing strategy.  Probably a colossal waste of time.

Total Stock Market Index Fund:  An index fund that tracks the performance of the entire US stock market.  By investing in such a fund, you are buying shares of all US companies on a value-weighted basis.

Practice Problems

1. I invest $4,500 in a total stock market index fund with no expense ratio.  After 35 years, how much money can I expect to have if the stock market returns an average of 9%?  Use annual compounding interest to solve for this question.

FV = $4,500(1.09)35 = $91,862.86

2. I invest $4,500 in a total stock market index fund with a 0.05% expense ratio.  After 35 years, how much money can I expect to have if the stock market returns an average 9%.  Use annual compounding interest to solve for this question.

FV = $4,500(1.0895)35 = $90,399.44

3. I invest $4,500 in a total stock market index fund with a 0.65% expense ratio.  After 35 years, how much money can I expect to have if the stock market returns an average of 9%?  Use annual compounding interest to solve for this question.

FV = $4,500(1.0835)35 = $74,511.72 

4. I invest $4,500 in a total stock market index fund with a 1.25% expense ratio.  After 35 years, how much money can I expect to have if the stock market returns an average of 9%?  Use annual compounding interest to solve for this question.

FV = $4,500(1.0775)35 = $61,350.38

5. I invest $4,500 in a total stock market index fund with a 0.65% expense ratio and a 3.5% front-end load fee.  After 35 years, how much money can I expect to have if the stock market returns an average of 9%?

Front-end fee = $4,500(0.035) = $157.50

Amount Invested = $4,500 - $157.50 = $4,342.50

FV = $4,342.50(1.0835)35 = $71,903.81

6. I invest $4,500 in a total stock market index fund with a 1.25% expense ratio.  After 35 years, how much money can I expect to have if the stock market returns an average of 9%?  Use annual compounding interest to solve for this question.

$4,500 is invested. 

FV = 4500(1 + 0.09 - 0.0125)35 = $61,350,38

7. I invest $4,500 in a total stock market index fund with a 0.65% expense ratio and both a front-end load fee and a back-end load fee of 3.5%.  After 35 years, how much money can I expect to have if the stock market returns an average nominal value of 9%?

I will only invest $4,342.50 since I pay a front-end load fee of $157.50. 

 FV = $4,342.50(1.0835)35 = $71,903.81

 Now, I will be charged a 3.5% back-end load fee ($2,516.63)

 FV after all fees:  $69,387.17

8. Question 4-7 are kind of silly.  Explain why it is unlikely that you would see such high fees for index funds.

Index Funds track the market.  They require little work to manage.  So, the fees are not going to be this high in the real world.

9. I invest with an incredibly gifted financial advisor.  She is amazing!  She routinely picks the best stocks and beats the market by 0.75%; she truly does have an advantage over the market.  Explain why hiring even this amazing financial advisor might still not be worth it.

Fees!  I still have to pay her.  If she, for example, earns 0.75% more than the market as a whole, but charges a 1% annual fee, she is ultimately performing 0.25% worse than the market, net of fees. 

10. Explain the three problems associated with using active management, as discussed in the book.  If you can’t explain these problems in your own words, you don’t understand it.

I'm not helping you here.  Read the book!

11. What is the benchmark for a large-cap mutual fund?

A benchmark is a comparison fund.  In this case, the S&P 500, which contains the 500 largest US companies, is a good comparison.  To understand how well the mutual fund has performed, we would compare its performance to the S&P 500.

12. Explain the difference between a financial advisor and a financial planner.

A financial advisor is primarily in the business of picking investments... usually trying to "beat the market" or achieving strongest possible returns at a given level of risk.  Financial planners are more thorough, providing advice on all things financially related... this could include health insurance, determining how expensive of a house a person could afford, etc.

13. Every year, I buy one share of the thirty largest US corporations on January 1st.  These purchases are my only investments I make all year.  Am I an active or passive investor?

This is kind of a silly question, but this shows how the lines can be blurred.  I would call this investor a passive investor.  It doesn’t appear they are trying to beat the market and they’re following basic rules to make investment choices.  But just because it’s passive doesn’t mean it’s wise!  While passive, this is not very well diversified and will inherently use a price-weighted approach to investing.