The Motley Fool has been a staunch supporter of index investing for years. Why? Because we revel in choosing an investment that outperforms most Wall Street Wise Guys while depriving them of their millions.
At least, that's the theory. But what do the numbers really say?
The Standard & Poor's Indices Versus Active Funds Scorecard (SPIVA) updates the ongoing battle every quarter. If you just looked at the third quarter (ended Sept. 30), indexing was a mixed bag. More than half (50.8%) of actively managed large-cap funds beat the S&P 500, and 65.1% of actively managed small-cap funds beat the S&P SmallCap 600. Only 26.4% of actively managed mid-cap funds outperformed the S&P MidCap 400.
However, as any sports fan will tell you, one quarter's performance won't indicate who will win the game. As time frames are extended, fewer funds beat their respective indexes. For the last five years, the S&P 500 outperformed 53.4% of large-cap funds, the S&P MidCap 400 beat 91.4% of mid-cap funds, and the S&P SmallCap 600 beat 69.4% of small-cap funds.
According to the SPIVA, indexing ranges from a 50-50 proposition (in the case of large caps) to a resounding success (in the case of mid caps). But this is based on one five-year period and assumes investors benchmark their investments to similarly sized indexes. So let's change the variables by looking at 10-year returns and comparing the numbers to just the S&P 500. After all, anyone investing in equities should be looking beyond five years, and the vast majority of indexed investments track the S&P 500.
Using Morningstar's Fund Screener, we learn that the average 10-year return of domestic stock funds was 8.19% vs. the S&P 500's 10.04%. That's a significant margin of outperformance.
However, that still leaves more than a handful of funds that managed to beat the index over the past decade. Of the 1,314 domestic stock funds with 10-year histories in the Fund Screener database, 135 no-load (i.e., commission-free) funds beat the S&P 500 by a percentage point or more, 51 outperformed by three percentage points or more, and the top 25 beat it by four percentage points or more. Ironically, the No. 1 fund came from the company that created index investing: Vanguard. Its Health Care Fund posted a 10-year average annual return of 19.98%.
(We chose no-load funds to emphasize that you don't need to pay a stockbroker 5% of your assets to get a good investment. Studies have already shown that paying a commission doesn't get you a better fund manager. And according to the Fund Screener, only seven of the top 25 funds over the past decade were "loaded.")
So if you want to beat the S&P 500 over the next 10 years, it's possible -- if you pick a fund that is among 10%-20% that can do it.
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