One of the biggest money debates is whether investors are better off buying actively managed funds or passively managed funds. Sounds complex, but they are easy to explain. A passive fund is one that is built and managed by a rule. For instance, a biotechnology index fund might buy and hold the 50 largest biotechnology companies. A global stock fund might buy stocks in the largest industrial economies in the world. By contrast an actively managed fund would employ portfolio managers to try to pick the best biotechnology companies or the best global stocks.
Which is better? Recognizing there are no absolutes, there is overwhelming evidence that passively managed funds are better for most investors. First, actively managed funds tend not perform much better than passive ones. Standard & Poor’s Index Versus Active (SPIVA) initiative, which has been measuring the performance of the two camps for about 15 years has found that over the most recent 10 year period, actively managed funds buying, say large U.S. stocks failed to outperform the S&P 500 index fund 88% of the time. Second, fees for index funds tend to be much lower. In the most recent study by Morningstar, mutual fund fees for large stock funds of approximately 0.72% were about seven times higher than comparable stock find fees of 0.11%.
Net, net? With the long term return on stocks of about 8.5%, giving up almost 10% of your profits to fees for underperformance is not a sound choice for most investors. This doesn’t mean your financial advisors is providing bad advice if they recommend a mutual fund. It does mean that you should question them very carefully why they are making the recommendation.
