Index Funds or Actively Managed Funds?

by TTMK on January 24, 2013 · 6 comments

When people talk about investing in stocks, for some that might mean buying individual stocks.  Doing active research on specific companies, and buying shares of some that you believe are a good value, has been a way that many people have approached stock picking and investing.  Of course, some people did away with the research aspect and bought on gut feeling, or some other “methodology”.  Everybody is an expert, right?

Well, not really.  That includes me, in terms of picking individual stocks.  This is why I think funds can be a great choice for many people.  The thing is, not all funds are created equally, and not all of them offer the same risk and reward profile.  Furthermore, some involve more costs than others!

Here’s the thing: quite often, index funds – which really don’t involve much active stock picking – outperform actively managed funds.  It’s interesting that funds that have professionals managing them can actually have lower net returns at times than those that are simply index funds, but that’s often the case!  Whether large, mid, or small cap – the appropriate S&P benchmark basket can very often outperform such actively managed funds.

When taking the manager out of the equation, you’re taking subjectivity and emotion out as well, to a large degree.  After all, how could these aspects be present in an index? The big thing is paying quite a bit less in terms of fees.  We can’t forget that fees impact total return!

Thing gets me thinking: why would people buy actively managed funds, given the quality performance of index funds in comparison?  Is it the idea that one could obtain potentially higher returns than with index funds, without the perceived risk of buying a small group of individual stocks? Or, is it simply the notion that an “expertly” managed fund should naturally outperform an index fund that someone passively holds.  After all, “active” is seen as better than “passive” in our society, on many levels.

I’m not a professional or advisor, but can say that I tend to prefer index funds over actively managed funds.

My Questions for You

Do you focus on funds, or individual stocks?

If funds, do you prefer actively managed funds or index funds?  I’m interested in the reasons behind your preferences.

{ 6 comments… read them below or add one }

AverageJoe January 24, 2013 at 7:56 am

While I focus on individual stocks, it isn’t the heart of my portfolio. Most of my portfolio is in passive index ETFs. I have individual stocks only because I think they’re fun to track.

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TTMK January 24, 2013 at 10:29 pm

Average Joe – they can be more fun to track, I know what you mean. Maybe set up a “mythical” portfolio of your best stock picks, and track it for fun instead!

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Oliver @ Christian Money Blog January 25, 2013 at 8:17 am

AverageJoe makes a good point that brings in the behavioral aspect to investing. Even if you show a person that index funds will beat individual stock picking or active mutual funds 90+% of the time, people still like to tinker with their investments.

As long as they take the same approach as AverageJoe, they will be fine. The problem comes from people with 100% of their retirement accounts in individual stocks or actively managed funds. When the market drops, they sell out. After it has regained most of what was lost, they buy back in. You know the way to wealth, “Buy high, and sell low!”

It’s hard to argue with Buffet. Even he agrees low cost index funds should be used by almost everyone.

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Emily @ evolvingPF January 24, 2013 at 8:33 pm

We have nearly all our invested money in index funds. I think people who invest in actively managed funds are either undereducated or overconfident. Sometimes active management works out, but the stats aren’t favorable.

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TTMK January 24, 2013 at 10:30 pm

Emily – I tend to prefer index funds as well.

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Matt January 25, 2013 at 4:00 am

Personally I like to have things under my own control and buy funds individually myself. I did consider buying funds previously, but shied away from them for a couple of reasons. In the UK, the FTSE 100 hasn;t really moved upwards significantly for a very long time now, so I don’t see indexed funds as providing any value. Looking at the managed funds though, you are right in one respect, however, there also seems to be the same handful of funds every year that outperform the market to a decent degree. Why anyone would buy one of the lesser alternatives, I have no idea, but if I was going to invest in a fund, it would be one of these star performers.

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