The Surprising Truth About Passive Investing
When it comes to investing, many people think that actively managed funds are the way to go. However, the numbers tell a different story. According to a recent report by BofA Global Research, index funds have consistently outperformed actively managed funds in recent years.
The Performance Gap
In 2024, only 36% of actively managed US large-cap mutual funds were able to beat the returns of their Russell 1000 index benchmarks. Meanwhile, the Russell 1000 index, which tracks US large-cap equities, had a strong performance thanks to the success of tech stocks like Apple, Nvidia, and Microsoft.
A Long-Term Trend
This isn’t a one-time fluke. According to S&P Dow Jones Indices, over the past 10 years, 85% of actively managed funds have underperformed the S&P 500. In the last three years, that number jumps to 86%.
Warren Buffett’s Advice
Even investing legend Warren Buffett recommends index funds. “In my view, for most people, the best thing to do is to own the S&P 500 index fund,” he said at a Berkshire Hathaway annual shareholders meeting. “People will try and sell you other things because there’s more money in it for them if they do.”
The Benefits of Index Funds
So why do index funds perform so well? For one, they’re often less expensive than actively managed funds. They also provide broad market exposure and are less prone to emotional decision-making. As financial planner Lazetta Rainey Braxton puts it, “Goals are being met consistently investment-wise without the additional risk of trying to track and follow active managers who can squeak out that extra return after their fees.”
The Rise of Index Funds
Index funds are becoming increasingly popular. According to Cerulli Associates, 52.6% of mutual fund and ETF assets were in passive funds as of the end of November. One major driver of this trend is the growth of target-date fund investing.
Target-Date Funds
Target-date funds are a type of index fund that automatically adjusts its asset allocation based on the investor’s retirement date. They’re often used in employer-provided retirement plans like 401(k)s. At Vanguard, for example, 83% of 401(k) participants use target-date funds.
Financial Advisers Weigh In
Financial advisers love index funds for their simplicity, cost-efficiency, and consistency. “The passive approach has been proven to work because of consistency, increasing contributions, time, and compound interest,” says Zaneilia Harris, a financial planner and president of Harris & Harris Wealth Management Group.
The Importance of Fees
Fees are a major consideration when it comes to investing. Index funds typically have lower expense ratios than actively managed funds. “Cost efficiency — passive funds, such as index funds, have lower expense ratios compared to actively managed funds,” says Leo Chubinishvili, a financial planner at Access Wealth.
Index Funds for Retirees
For current retirees, index funds make a lot of sense. They provide broad market exposure, are easy to manage, and have low tax costs. “Running a streamlined investment portfolio is important at any age, but it’s particularly beneficial as we age,” says Christine Benz, Morningstar’s director of personal finance.
A Caveat
While index funds have many benefits, they’re not perfect. In a bear market, they may not perform as well as actively managed funds. However, for most investors, the benefits of index funds far outweigh the risks.
Leave a Reply