Please ensure Javascript is enabled for purposes of website accessibility

Ask a Fool: Should I Invest in Index Funds or Actively Managed Mutual Funds?

By Matthew Frankel, CFP® - Feb 23, 2018 at 12:00PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Fund managers should be able to beat the market, right?

Q: Are index funds or actively managed mutual funds the smarter choice?

There isn't an easy answer, but here are the key differences and some facts that could help you make your decision. In general, however, I think index funds are the best investment for most people who don't have the time or desire to research individual stocks.

The key advantages of index fund investing are cost and the guarantee of matching the market's performance.

Because the fund's managers don't actually need to do any stock picking, index funds tend to have significantly lower fees. For example, the average actively managed large-cap stock fund has an expense ratio of 1.25% while the average S&P 500 index fund charges a minuscule 0.15%. Over time, this difference can really add up.

And while they'll never beat the market's performance, by definition index funds guarantee that you'll do as well as the market over time. The S&P 500 has historically generated annual returns of nearly 10%, so this can effectively build wealth over time, especially with the low fees.

On the other hand, actively managed mutual funds have the chance of beating the market, but their fees put them at an inherent disadvantage. As legendary investor Warren Buffett has explained it, if half of fund managers beat the market and half don't, when you account for the fees, the average fund will underperform.

The statistics confirm this. Just 1 in 3 active managers of large-cap funds were able to beat the S&P 500 in a recent year, and the figures were even worse for mid-cap and small-cap fund managers. And over the last 15-year period, a staggering 92% of large-cap managers underperformed the market.

That said, if a fund has a particularly strong and sustained record of performance, it could be worth the additional fee. For the most part, however, index funds are the better bet.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
S&P 500 Returns

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 06/30/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.