Why Mutual Funds underperform?

Two factors why Mutual Funds underperform:

1. Turnover

Turnover represents how much of a mutual fund's holdings are changed over the course of a year through buying and selling. Because buying and selling stocks costs money through commissions and spreads, a high turnover indicates higher costs (and lower shareholder returns) for the fund.

2. Cash Reserves

The other principal category of actively managed mutual fund behavior that hurts shareholders is the cash reserves that make up such a large percentage of so many mutual funds. For various reasons, actively managed mutual funds don't invest all the money at their disposal, but instead maintain cash balances of approximately 8%.

There are essentially two reasons for this cash reserve maintenance. First, mutual fund managers are keeping money on hand in case shareholders decide to sell their shares suddenly.

Additionally, mutual fund managers apparently keep some money in cash under the belief that doing so will provide them with flexibility for those occasions when there is a fire sale in the market. This is the "buy low, sell high" theory -- managers apparently believe that they can time the market, sell off some of their holdings when the market is "too high," and buy back some shares when there is a better price available.

Source: Google search (source wasn't recorded at time of reading)