Another Vote for Index Funds

In Money magazine's interview with legendary fund manager Bill Miller this month, they ask him why investors shouldn't just put their money into an index fund versus trying to find the next great mutual fund manager to invest their money. His response:

The odds of getting a manager who can outperform over 10, 15 or 20 years are about one in four. So there's a very significant case to be made for having most of your money in index funds.

The fact is, however, that index funds do not give you the results of the index. They give you the results of the index less your costs, which are small but real.

To have a prayer of outperforming, you've got to have some money in active management.

Let me translate this:

• You have a 25% chance of finding a fund manager who can beat an index fund. Looked at the other way, there's a 75% chance that an index fund will outperform any managed fund you select. Seems pretty obvious to me that index funds are the clear winners based on the numbers here.

• There are costs associated with index funds too, though they are generally low. And, as we all know, keeping costs low is a key part to making the most of your investment.

• If you think you can beat an index fund by going with an actively managed fund, you better be a praying person. ;-)

Ok, I stretched that last one a bit, but I think you get the point overall. What he's really saying is that in the vast majority of cases, an index fund is a better investment than an actively managed fund. He gives 75% to 25% advantage to index funds, but I think the advantage is bigger than that. Here's what the Motley Fool has to say on the issue of index funds outperforming actively managed funds:

Almost all actively managed equity mutual funds over time lose to the market averages. And those funds that do beat the market's return typically do so for only a very short period of time, and then quickly reverse course.

So the odds are MUCH better for us all if we stick with index funds versus actively managed stock funds.

Mr. Miller closes the interview with a comment I also want to highlight. He says:

Being willing to lower your average cost [by buying more when a stock drops] is a great strategy. But it's difficult.

See? I told you so. ;-)

Comments

[Luke]

I would love to hear a couple large cap US funds and an international fund or two that are actively managed that Bill Miller would recommend.

I would love to read the names of the funds in that 25% so I could make up my own mind. I am big into Vanguard, but I am all ears if anyone has some managed funds with fair expenses for me to look into :)