Index Funds Consistently Outperform Actively Managed Funds
A recent survey once again shows what has long been the case, that index mutual funds consistently outperform actively managed mutual funds (see below). So if that’s the case then why do so many people invest in actively managed funds?
5 Common Reasons People Fall For Actively Managed Funds
Reason #1 – Ignorance
Some people simply do not understand the long-term performance of index mutual funds handily beats that of actively managed mutual funds.
Reason #2 – Sales Efforts
Firms make much more money off of actively managed mutual funds, often 1%-2% of principle per year vs. 0.18%-0.25% for many index funds. As a result firms put relentless efforts behind selling actively managed funds (with great success!)
Reason #3 – Greed/Temptation
By definition you can’t beat the market if you’re in an index fund designed to mirror the market. What are you, some kind of wimp? And so people pour billions into actively managed funds only to see their returns lag year after year.
Investor Pride – This is a close cousin of “greed/temptation.” Here’s how the story goes. Yes, there are lots of lousy actively managed mutual funds out there, but by virtue of your penetrating insight you are smart enough to pick a fund that will beat the market…and that’s how the train wreck begins.
Reason #4 – Fund Manager Pride
So despite the sub-par performance of actively managed funds, show me one that doesn’t have a fund manager that thinks they can be the market every year. If you can find one then I would love to see what the marketing material looks like, “Invest with us – we guarantee we’ll charge you more and underperform relative to the market in the process!”
Reason #5 – Performance Chasing
Maybe you’ve had a reality check and realize if you’re like most regular you can’t consistently beat the market (but don’t worry, the pros can’t either). But wait, you don’t have to be smart enough to beat the market, right? You’ll just find some mutual fund rankings and pick the ones that performed the best last 1-3-5 years, right? That’s called performance chasing, which is another name for buying high and often selling low (instead of the other way around!).
Low Cost Index Funds are the Best Long-Term Investment Strategy
So what’s the solution? What’s a good investment strategy for regular people? Unless you’re able buy stock or another investment at an amount that’s comfortably below the market price (such as pre-IPO stock) then you’re best bet for the long-term is to invest in low-cost index funds (view Best Vanguard Funds for specific recommendations). It may not get you riches anytime soon but hey, slow and steady worked out pretty well for the tortoise!