Which Is Better?

One of the biggest money debates is whether investors are better off buying actively managed funds or passively managed funds. It sounds complex, but both 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 and pick the best biotechnology companies or the best global stocks.

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Which is better? Recognizing that there are no absolutes, there is overwhelming evidence that passively managed funds are better for most investors. First of all, actively managed funds don’t 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%.**

All things considered, with the long term return on stocks around 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 advisor is providing bad advice if they recommend a mutual fund. It does, however, mean that you should question them very carefully when they make the recommendation.

* Anonymous, (November, 2019). S&P Indices Versus Active (SPIVA®). S&P Dow Jones Indices. Retrieved November, 2019
** Oey, Patty, (May, 2018). Fund Fee Study: Investors Saved More Than $4 Billion in 2017. Morningstar. Retrieved November, 2019