Actively Managed vs Passively Managed Funds
Learn why people still invest in mutual funds over index funds?
Why do people still invest in mutual funds over index funds?
An index fund is is a type of fund that mirror the performance of a specific market index (eg. S&P 500). It contains small percentages of stocks that make up the index, and gives the investor a diversified selection of stocks. It is passively managed, meaning the fund manager does minimal work.
A mutual fund is where investors pool their money together and give it to a portfolio manager, where he or she will select a variety of stocks for the investment. Then the investors will split the holdings amongst themselves.
Data has shown that index funds (passively managed) have historically performed better than mutual funds (actively managed). If the S&P 500 returned 10%, a mutual fund would expect to return only 9%, whereas an index fund would return around 9.8-9.9%. That’s also disregarding the fees. Due to mutual funds being actively managed, many annual fees incur. The average mutual fund incurs expenses of 1.3%, which is a significant amount. That means if the mutual fund will have to outperform the market index by 1.3% just to break even.
On the other hand, index funds incur much lower expenses, ranging less than 0.2%.
So why do people still invest in mutual funds over index funds?
Does Higher Cost Equal Better Quality?
Many investors have the tendency to believe that since they are paying more money for something, they are getting a better result out of that good. Clearly that logic is flawed, as data from the past 30 years has countered all those assumptions.
Finding good deals
With an actively managed fund, an investor may have a better chance at finding undervalued or low-priced stocks with high potential. Investing in actively managed funds is a competition amongst the investing community. If people decide to pull their money out, others have a higher chance of finding undervalued shares. It’s like panning for gold. You have a much higher chance of finding a piece when you are by yourself, compared to having dozens of miners surrounding you.
“I can find a good fund manager that beats the market”
No you can’t. This is another perception or idea that many investors have. They think they can find an investor that can beat the market, but once again, the statistics prove them wrong.
While mutual funds may seem more tempting to invest in because of supposedly higher quality or potential, index funds have consistently shown to be the better investment. With the low costs, higher turnout, and higher guarantee, it is an overall much safer and smarter investment. In this case, simplicity is truly key.