When it comes to investing in stocks, some of us like to be highly active stock pickers. Others among us like to invest passively, even to the point of a “set it and forget it” strategy.
One example of active vs passive can actually be indirect, through mutual funds. In this example, as many of us know, we aren’t exactly picking the investments in a fund. Rather, the fund manager is picking the investments. Sometimes, these funds can actively trade many stocks. So even though we buy into mutual funds at a price per share (based on the net asset value) similarly to how we do a stock, there can be tons of trades going on with our money even if we ourselves don’t sell anything. The fund manager is behind the scenes making the moves, making this an active strategy of sorts.
On the other hand, if we buy a mutual fund that’s simply index-based, there’s very little activity involved. An S&P 500 index fund, for example, is set up to mirror the performance of the actual index. The brain work is taken out of the process, and there isn’t a fund manager’s acumen influencing the performance of the fund. It’s all based on how the individual stocks in the fund perform.
This of course brings us to the established, oft-discussed topic of index funds vs. actively managed funds. Thinking about it based on what we’ve discussed above, we’re really choosing between:
- Professional fund manager input into our investment; or
- No professional input, just independent stock performance guiding our investment
On the surface, it just seems logical that all things being equal, a professionally managed fund should outperform one that’s not professional managed, right? We’re often told about the virtues of index funds, and passive investing, but shouldn’t there be value to having a professional guide the stock picking within a fund?
Well, maybe there isn’t always value to a a professional actively managing a fund.
An article I saw on Moneywatch further supports the case for index funds over actively managed funds. According to this article, data from Standard & Poors shows that active fund managers have been consistently outperformed by index-based benchmarks. This finding is across cap size and covers the last 3 years.
Here’s the extent of the disparity with these actively managed funds:
- Large-Cap focus: 64% were outperformed by the S&P 500
- Mid-Cap focus: 75.1% were outperformed by the S&P MidCap 400
- Small-Cal focus: 63.1% were outperformed by the S&P SmallCap 600
Thus, for all the extra fees that are being paid, investors are getting nothing back. In fact, one could say that investors are getting punished for going with actively managed funds!
Now, there are some funds that clearly do outperform the market. However, the majority haven’t been doing so.
Personally, I’ve been a fan of index funds, but have a mix of index and actively managed funds. At this point, it’s hitting home that maybe I should jettison the actively managed funds and replace them by adding additional investment in index funds?
I suspect that many people (including me, apparently), have previously found index fund investing to be “average” or lacking risk taking or a pursuit of wealth. Who wants to be average, right?
Well, maybe average actually means winning in this case!
My Questions for You:
If you own mutual funds, do you focus on index funds?
What do you think about the notion that the pursuit of average, in terms of market returns, is actually a winning strategy in some ways?
Why do you think people pursue actively manage funds, despite the evidence that index funds outperform them?