Once Again, These Funds Win

Those who've been reading Foolish fare over the past 15 years know that we've long sung the praises of index funds. We've never hesitated to note that the majority of managed mutual funds underperform the market -- a truth still in full effect today.

According to Standard & Poor's Index Versus Active Fund Scorecard (SPIVA), reflecting data through the end of 2010, index funds continue to wallop most of their actively managed peers:

  • Though almost 51% of domestic stock funds outperformed their benchmark in 2010, managed funds tend to underperform over longer periods. As many as 80% or more have done so in the past, and nearly 58% of domestic stock funds underperformed over the past five years.
  • Certain asset classes posted much starker numbers in this report: Among large-cap and mid-cap growth funds, for example, only 18% outperformed their benchmark over the past five years. That represents a lot of disappointed investors, at least among those who check how their funds have been doing relative to the market.
  • The only category to beat the benchmark over the past five years was large-cap value, with 65% outperforming. 
  • Interestingly, over the past five years, some 25% of funds disappeared, either through liquidation or merging into other funds.

Lessons to draw
Clearly, we shouldn't assume that even active funds managed by savvy professionals will beat the market. Many, if not most, of the funds that disappeared were struggling, having lost assets and investors' dollars. Most of the surviving funds just didn't do as well as a simple index fund -- and along the way, they charged investors far more than most.

If you don't want to think much about your investing, index funds are the way to go -- even Warren Buffett has recommended them, and there's no shame in seeking average returns. Exchange-traded funds (ETFs) offer easy access to lots of indexes. You can instantly have broad-market exposure via Vanguard Total Stock Market ETF  (NYSE: VTI  )  or SPDR Trust  (NYSE: SPY  ) .

The Vanguard Emerging Markets Stock ETF (NYSE: VWO  ) will plunk you into many critical developing economies, while the Vanguard Total World Stock Index ETF (NYSE: VT  ) gives you exposure to all the world's economies. If you're already substantially invested in the U.S., you can factor out our local economy with the Vanguard FTSE All-World ex-US ETF  (NYSE: VEU  ) .

Be picky
The data also suggest that actively managed growth funds don't do as good a job of beating their benchmarks as value funds. So you might want to go with active funds for value stocks, but stick with index funds for growth. You can do so via the iShares S&P 500 Growth Index (NYSE: IVW  ) , or for smaller-cap companies, the iShares Russell 2000 Growth Index (NYSE: IWO  ) .

Even when you go with active management, it's smart to seek no-load funds with low fees, strong managers, and solid track records. Low turnover and a concentrated portfolio can also make a powerful positive difference in an actively managed fund's performance.

The bottom line: Choose your managed funds carefully. If you don't have the interest or energy to study funds, consider just going with one or more index funds. If nothing else, the odds will likely favor you.

If you'd like pointers toward a bunch of outstanding funds, as well as model portfolios for different kinds of investors, take a free test-drive of our Rule Your Retirement newsletter.

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. The Fool owns shares of Vanguard Emerging Markets Stock ETF.  Try any of our investing newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool is Fools writing for Fools.


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  • Report this Comment On March 17, 2011, at 1:53 AM, easyavenue wrote:

    Should be required reading for every new Fool. And a refresher for us old ones, too.

    Well done Selena!

    EA

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