Index Mutual Funds Are Still Not Popular, But

Are you investing in equity mutual funds? If so, are you using index funds or actively managed funds?

I have mentioned a few times in the past that even though I use all index funds in my retirement savings accounts, I have nothing but actively managed funds in taxable accounts. The reason isn’t that I don’t like index funds (otherwise, I would use no index funds at all). It is mainly because that was where I started seven years. Then later as I keep making purchases into those funds every month, I think that it doesn’t make too much sense to start all over again with index funds. So I decide to stick to what I have. Plus, I have been quite satisfied with how my funds performed :) , until last year :(

Obviously, I am alone in the actively managed fund arena. In fact, index funds are not as popular among investors as you may think, despite that experts have been urging for years to use passive funds to keep costs down. As you can see from the following chart, which shows the percentage of index fund assets as total assets in equity mutual funds from 1985 to 2007. Clearly, the growth in index fund assets had a nice run in the last decade, but stalled in recent years. Since 2002, the ratio hovers around 11%, which isn’t a great number, considering the benefits of investing in index funds, such as low-cost and tax efficient.

Index Mutual Funds

So why do people love actively managed funds over passive funds?

The main reason is the illusion that actively managed funds, which require the fund manager to do researches to identify companies to invest (that causes higher fees BTW), can outperform index funds if the fund manager buys the right stocks at the right time (I admit that was one of the reasons I started with actively managed funds myself). Investors want better than average returns, which are what they get when investing in index funds. But is that the reality?

Not really. Not even in a horrible year like 2008.

According to a MarketWatch article which cited study from S&P early this week, 70% of large-cap stock funds that use the S&P 500 index as the benchmark failed to beat the index, which was down some 38% last year. And domestic equity funds aren’t the only one that lagged the benchmark. 80% of actively managed bond fundsĀ  underperformed their respective benchmarks across all categories, while nearly 90% of actively managed emerging market funds were beaten by the S&P/IFC Emerging Markets Index. But that’s not the whole picture. There are still active funds that beat the S&P 500. And Morningstar‘s study found that

the average fund beat all but one of its category Russell and Morningstar indexes over 10 years. It also beat the S&P indexes in five of the nine categories.

The article points out that investing in actively managed funds aren’t really about picking with funds to invest. It’s rather about picking the fund manager with proven recorders. That’s not an easy job of course. Even seasoned managers like Bill Miller failed.

My actively managed funds didn’t perform well last year and, as I found, costs of some of my funds have increased a little bit comparing to the year before. But I have no plan to make any dramatic swift now.

*Data source: ICI 2008 Investment Company Fact Book

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6 Responses to “Index Mutual Funds Are Still Not Popular, But”

  1. Jason Unger |  Apr 23, 2009 at 2:45 pm

    This is just more evidence that nearly everyone should be investing in index funds for their retirement.

    Add this to the finding that only 3% of actively managed funds beat the S&P 500 index over the last 20-year period (see findings here), it doesn’t make sense to buy-and-hold actively managed funds.

    And we haven’t even talked the higher fees that managers require.

  2. best mutual fund |  Jun 19, 2009 at 4:57 am

    Ya i agree that mutual fund is not that much popular as compare to index fund but if some one is planning for long term investment than mutual fund is the best option.