Comments on: Index Funds vs. Active Mutual Funds

By: Trust Deeds

Trust Deeds — Sun, 11 Apr 2010 04:06:09 +0000

Index funds will overall beat the average fund manager. How could you trust your money to a “professional” who probably can’t even beat an average return earned by an index fund.

By: Chandler Arizona CPA

Chandler Arizona CPA — Mon, 15 Feb 2010 00:31:10 +0000

I think index funds are the way to go. Overall, they will outperform the average actively managed fund. In this market, who trusts fund managers anymore?

By: Mike

Mike — Thu, 11 Feb 2010 20:07:04 +0000

Monevator: You’re absolutely right. I often forget about how counterintuitive the whole idea is. (Once you’ve had the math explained, it’s plain as day.)

By: Monevator

Monevator — Thu, 11 Feb 2010 19:57:09 +0000

@Niklas – Great point. One of many reasons why I always steer friends who ask towards index funds is I know they’re not going to underperform. Most people hate losing money. A neat illustration of how ably the fund mangement industry obfuscates away its relatively poor performance is that most active investors don’t realize they’re doing worse.

@Mike – I think there’s an even simpler reason for why active investing appeals than playing to people’s mental egos. Basically, if you don’t spend your time researching this stuff up, it’s counterintuitive to the average person that paying for a persont to do their job does less well.

Where else is that true? We don’t say you get drugs randomly from a robot as well as a doctor, or take legal advice from a schoolboy.

You and I (and Sharpe) know it’s not the same thing at all, and it’s why you’re right of course to focus on the maths, but for the average person who in most walks of life pays more and sees a better product/service, passive investing is incredibly counter-intuitive.

By: Mike

Mike — Wed, 10 Feb 2010 23:21:35 +0000

Niklas: I absolutely agree. Even in the absence of fees, I don’t see active management as a “value-added” service.

As to the tipjar, that’s a neat idea. (And thanks for the kind words!) So far I’ve been trying to stick with monetization strategies that help people at the same time as providing me an income–books, most particularly.

By: Niklas Smith

Niklas Smith — Wed, 10 Feb 2010 22:46:33 +0000

How true – and thanks for the link to the Sharpe paper.

But the argument is even stronger: even if fees were the same for both active and index funds, index funds would still be the right choice for most investors.

Any investor who is risk averse will prefer an expected return of 7% plus or minus 1% to an expected return of 7% plus or minus 3% – it’s simply rational to minimise your uncertainty if the expected outcome is the same. Now consider that (ignoring fees) the index fund gives you the average market return for certain, and that active management will give you the same return (on average – mathematically anything else is impossible), though some funds will outperform and others will underperform. If the expected return is the same, which option do you choose: get it for certain, or roll the dice?

QED.

P.S. Mike, you should set up a tipjar for this blog – your work is well worth a few tips
This site makes it easy: http://tipit.to/

By: Mike

Mike — Wed, 10 Feb 2010 20:49:58 +0000

RJ: Sharpe’s Arithmetic of Active Management is arguably my favorite article/paper ever written about investing–concise, understandable, and unassailable logic.

RetirementInvestingToday: We are indeed lucky here in the US. Still, you’re paying a lot less than even some of us yanks.

Blair: Agreed. I’ve always liked that analogy.

By: Blair

Blair — Wed, 10 Feb 2010 20:39:03 +0000

I found that Bill Schultheis’ “Outfox the Box” provided a good illustration of the difference between active mutual funds and index funds. He does perhaps exagerate the difference, but taking fees into account he probably isn’t too far from the truth.

http://www.coffeehouseinvestor.com/?page_id=7

By: RetirementInvestingToday

RetirementInvestingToday — Wed, 10 Feb 2010 20:03:47 +0000

So true. It’s why I’ve gone down the road of index tracking rather than active management whereever possible. The negative from my side is that being based in the UK index tracker funds/ETF’s still have extremely high fees compared to the US.

With my retirement investing strategy my average fees for my total asset allocation is still running at 0.6%!

By: RJ Weiss

RJ Weiss — Wed, 10 Feb 2010 16:18:13 +0000

Thanks for pointing me to that William Sharpe article. This makes it a lot easier to explain the advantages of index funds to others.

Something very similar can be said for taxes to.