Index Investing Out-Performs Most Actively Managed Funds, Costs Taxes are Why

Here's a piece a reader pointed to that details many of the benefits of index investing from the NY Times. I'll highlight a couple of their main points including how indexing out-performs most actively managed funds on a regular basis:

This year through September, only 28.5 percent of actively managed large-capitalization funds — which try to beat the market through stock selection — were able to outpace the S.& P. 500 index of large-cap stocks, according to a new study by S.& P. In the third quarter alone, it was even worse, with only one in five actively managed large-capitalization funds beating the index.

Over the five years through the end of the third quarter — a span that included both bull and bear markets — only 29.1 percent of large-cap funds managed to beat the S.& P. 500. What’s more, only 16.4 percent of mid-cap funds beat the S.& P. 400 index of mid-cap stocks, and 19.5 percent of small-cap funds outpaced the S.& P. 600 index of small-company shares. “The long term does seem to favor the indexes,” Ms. Pane said.

There are many advantages of index funds, but the biggest is that they simply perform better than most other options. Why is this? Well, let the master of index fund investing tell us:

For John C. Bogle, founder of the Vanguard Group, which started the first retail stock index fund 30 years ago, the recent success of indexing is self-evident. “The reality is, fads come and go and styles of investing come and go,” he said. “The only things that go on forever are costs and taxes.” And by simply buying all the stocks in an equity benchmark and holding them for the long run, traditional index funds minimize the transaction costs and capital gains taxes associated with investing, he said.

Yep, costs matter if you want to maximize returns. Quite simply, a fund with a .3% expense ratio starts with a 1% advantage over a fund with a 1.3% expense ratio. It's a big lead that most more-expensive funds simply can't overcome. And it's one that makes a big difference in your overall return through the years.

If you want to know more about index fund investing, I recommend the books The Bogleheads' Guide to Investing and The Smartest Investment Book You'll Ever Read: The Simple, Stress-Free Way to Reach Your Investment Goals. Both of these would make great presents this holiday season for those on your list interested in investing -- or for yourself, as a way to spend some of that holiday money you receive this year.

Comments

[Mike]

Doug, as a regular reader I would like to suggest that you take your spam elsewhere, as your website has zippo to do with this blog. There are no valuable tips on your website. There are no valuable resources there either.

[Sfmoneygal]

Thanks for highlighting the article's main points! I discovered index funds a year ago after a friend suggested reading "a random walk down wall street," another great book on why index investing beats picking individual stocks. wish i knew that when i gave my dad savings from my paycheck and he picked individual tech stocks that plummetted.

[FMF]

Mike --

Thanks for the comment -- and for looking out for people mis-using the comments section. I have deleted Doug's "comment" for the reasons you listed.

[Daddy Paul]

I am frankly surprised with only 20% small cap funds being unable keep pace with their index.
I would think it very hard for a large cap managed fund to beat the index.