Investing in market-tracking index mutual funds, known as passive investing, is getting boring.
But the truth is in the returns: index funds routinely destroy funds actively managed by professional stock pickers.
Last year was no exception, according to a new report from BofA Global Research. Professionally managed funds have had a hell of a time beating the returns of passive indexes that track US large-cap stocks.
For example, only 36% of actively managed US large-cap mutual funds have outperformed their Russell 1000 benchmark in 2024.
The Russell 1000, a stock index that provides exposure to companies like Apple, Nvidia, Microsoft, Amazon and Facebook parent Meta, had a lot of oomph behind it with these hot tech stocks, to be honest.
But it’s not by chance. Among the more than 1,900 US equity mutual funds and ETFs tracked by Morningstar, 19% outperformed the S&P 500, which returned 25%, and only 37% outperformed their category index in 2024.
For two decades, S&P Dow Jones Indices has produced “scorecards” that compare the performance of actively managed stock funds and fixed income mutual funds with various indexes over different time frames. Over the past three years, for example, 86% of actively managed funds have underperformed the S&P 500. Over a 10-year period, 85% of those funds insufficiently performed S&P 500, according to data.
Warren Buffett is one superstar who loves low-fee index funds.
“People will try to sell you other things because they’ll have more money in it if they do. And I’m not saying it’s a conscious act on their part. Most good salespeople believe their own stupidity…that’s why I suggest people buy an index fund.”
Berkshire Hathaway CEO Warren Buffett drives through the exhibit hall at the company’s annual meeting in Omaha, Nebraska, April 29, 2022. REUTERS/Scott Morgan ·Reuters
I’m a big fan of investing my retirement savings in index funds because it’s easier and cheaper than picking individual stocks and bonds to buy and sell at the perfect time.
And you’ll probably ride off stock market slides if you stay the course in diversified baskets of stocks and bonds.
Sure, it’s more like a gentle spin on a teacup at Disney World’s Mad Tea Party than Maxx Force Six Flags, but for most of us, it’s a ticket to ride.
Investors who choose actively managed mutual funds tend to pay higher fees than passive investors, which is a problem given the imbalance in performance.
Calling index fund investing passive is also perfect, since the point of owning them is to cool your jets when the markets get cloudy.
Investing in index funds — balanced between stocks, such as the S&P 500 index, and fixed-income bond funds and put on auto-pilot — is classic advice for many investors, especially those who shun retirement funds. And if you’re already retired, managing your expenses helps increase your take-home returns.
“I anchor client investments in a passive index strategy because history continues to show that passive investments outperform active managers over long periods of time,” Lazetta Rainey Braxton, Financial Planner and Founder The true wealth of the Coteriesaid Yahoo Finance. “Goals are met consistently in terms of investment without the added risk of trying to track and trace active managers who can make that extra return after their fees.”
Although fees have been falling in recent years, in 2023 index equity mutual funds had an average asset-weighted expense ratio of .05%, according to research by the Investment Company Institute (ICI), compared to 0.42% for actively managed equity mutual funds.
Index funds are all the rage these days. About 52.6% of mutual fund and ETF assets were in passive funds at the end of November, compared with 49.6% in November 2023, according to research and consulting firm Cerulli Associates.
One big driver of the shift to index funds: the rise of investment in target-date funds.
I’m guessing that many of you already invest in index funds in your employer-provided retirement plans, such as your 401(k). Almost all 401(k) plan sponsors and most state auto-IRA programs use target date funds when they automatically enroll workers in a retirement plan.
These funds usually consist of index funds.
With a target date pension fund, you pick the year you want to retire and buy a mutual fund with that year in the name (such as Target 2044). The fund manager then splits your investment between stocks and bonds, adjusting this to a more conservative mix as the target date approaches.
At Vanguard, for example, 83% of 401(k) participants used target-date funds, and 70% of target-date investors had their entire account invested in a single target-date fund. That’s up from 6 in 10 in 2022 and more than double from 2013, according to Vanguard.
“The passive approach has been proven to work,” Zaneilia Harris, financial planner and president of Harris & Harris Wealth Management Group, told Yahoo Finance. (Photo courtesy of Zaneilia Harris)
I reached out to financial advisors to get their take on the role index funds should play in retiree accounts. Here’s why they love them too:
“The passive approach has been proven to work because of consistency, compounding, timing and compound interest,” Zaneilia Harris, financial planner and president of Harris & Harris Wealth Management Group, told Yahoo Finance.
“John Bogle, the grandfather of passive investing, promoted it to be simple, easy and profitable,” she said.
But she also advises her clients to add some juice. “Some investors may take a more strategic approach to growing their retirement savings, such as adding a few individual stocks,” Harris said.
For Leo Chubinishvili, a financial planner at Access Wealth, it’s all about those tiny core fees. “Cost efficiency – passive funds, such as index funds, have lower expense ratios compared to actively managed funds,” he told Yahoo Finance. “Compounds to save costs over time, benefiting savers in retirement. And passive investing can reduce the temptation to make frequent adjustments based on market volatility.”
Sure, it’s more like a gentle spin on a teacup at Disney World’s Mad Tea Party than Six Flags’ Maxx Force, but for most of us, passive investing is a ticket to ride. (Getty Creative) ·skynesher via Getty Images
For current retirees, index funds make sense for several key reasons, Christine Benz, Morningstar’s director of personal financesaid Yahoo Finance
“Maintaining a streamlined investment portfolio is important at any age, but it’s especially beneficial as we age. Index funds give you broad market exposure in a simple package. You won’t have to worry about management changes or portfolio changes with broad market index funds, and it’s also easy to see if rebalancing is in order and where to do it.”
She added, “reducing the moving parts in your portfolio makes life easier for your loved ones if they need to manage your finances at any time.”
Tax breaks are another big reason why they are attractive to retirees. Index fund portfolios (especially ETF portfolios) tend to have low tax costs, especially on the stock side, Benz said.
“Given that many investors’ portfolios are peaking at retirement and include a significant proportion of non-retirement taxable assets, reducing tax pressure is another way to increase returns,” she said.
One caveat: “Passive is cheaper than active management and does very well in a bull market,” said Cary Carbonaro, a management consultant at Ashton Thomas. “It’s in a bear market where it might not do so well.”
