Do index funds really work better than an actively managed portfolio?

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  • NC
    Lv 7
    1 decade ago
    Favorite Answer

    Not exactly. They work better than the MAJORITY of actively managed portfolios that ONLY contain the index's member stocks IN THE LONG RUN.

    There are a few managers who seem to consistently outperform the market through security selection or market timing (some charge fees that exceed their outperformance, so they only outperform on before-fees basis, but not on after-fees basis). There are also managers who can enhance returns by investing in securities that are not included in the benchmark index (this is called "investing outside the benchmark").

    One of the simplest and best known ways to enhance the performance of an index portfolio is the so-called "buy-and-write strategy": you continue to hold your index portfolio, but also write a not-too-far-out-of-the-money call option on it and invest the proceeds in the same index you are holding.

    Another is "portable alpha"; instead of buying the index, you buy futures on it and invest the remaining cash in high-grade commercial paper and soon-to-mature corporate bonds while simultaneously short-selling Treasury bill futures. The resulting portfolio returns whatever the stock index returns plus the yield spread between the high-grade corporates and Treasuries minus commissions and fees.

  • 1 decade ago

    Index funds do work better than SOME actively managed funds, and they work a lot worse than others. The key word is "consistently" which many people have taken to mean "consecutive years" of out performance. In that case, only one fund manager, Bill Miller has done that (for 15 years) and he fell behind the S&P 500 index for 2006. But, if you go to any financial web site that covers mutual funds, you will find many good funds that have not beaten their index "consistently" but have done so enough years so over a 10, 15, 20 whatever year span, they have a better total (after fees, trading costs etc) return. They are not that hard to find.

    Remember back in 2000 when WorldCom, Tyco, Enron, Global Crossing, etc. were doing well, had large market caps so the index funds had to buy their shares? Managed funds didn't need to buy such risky shares and could sell all their holdings at the first sign of trouble, while index funds could only sell enough to keep their positions equal to the company's market position.

    I disagree with Gregory's points. 1) over a 30 or 40 year investment time span, being able to sell a few hours earlier will not make a "hill of beans" difference. Time in the market, not market timing is the key to success (quote from I believe Peter Lynch, the most successful mutual fund manager). If you are only investing for a few weeks or months, mutual funds are not the instrument to use so he is comparing apples to oranges.

    2) "...active managed mutual funds take the dividend for themselves..." Highly illegal and just not true. I have always gotten all my dividends from my mutual funds. Plus you have the option of reinvesting them (since you buy an ETF through a brokerage house, some brokers, like Scottrade, do not let you reinvest for free) for free so you get the full 10%.

    3) Again Time in the market, not market timing is the key... When the index goes down, consider the shares "on sale" and just like any product "on sale", buy more. 4) answered in the first couple of paragraphs.

  • 1 decade ago

    There are four things that can help you with an index fund:

    1. Stop loss orders and general selling. With Index tracking ETFs you can pull the plug quicker than on a mutual fund where the sell and buy price is at the end of the day.

    2. ETFs that track indexes often have dividends when are added to the total. If the index went up 8% and there is a dividend of 2%, you gained 10%. On Mutual funds, chances are you will see just an 8% increase because the people running it take the dividends for themselves and with an active mutual fund buying and selling wthin that index, you might see less than 8% because of the buy and sell fees and taxes within the mutual fund that you won't see on your statement.

    3. You can short index funds, but you can't short mutual funds. This way you can make money when the index goes down as well as the index going up. If you want to make money when the index is going down as well as up, you will need to switch between two different mutual funds (one mutual fund that thinks the index is going up and another mutual fund that thinks the index is going down).

    4. Most active mutual funds can't beat the index. Other mutual funds are happy to just track the index (those mutual funds are called trackers) and bill you for it.

  • Anonymous
    1 decade ago

    Most of the time, yes. The best index funds have very low expense ratios because they are unit trusts that buy and hold and have no brokerage expense or turnover.

    Most active managers do not consistently beat their index benchmark. Some do, but most dont, and on average the active management doesnt justify the fees versus a passive indexed portfolio.

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  • Anonymous
    1 decade ago

    No.

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