One of the larger debates that is ongoing in the investment industry is whether or not people should invest in active or passive investment funds. Active funds are those that are run by fund managers who attempt to beat average market returns in their particular sector. Active funds can invest in small-, mid-, or large-cap stocks, bonds, commodities, or specialize in a particular sector of the economy or a particular country or geographic area.
Passive funds are funds that try to match a particular stock index, such as the S&P 500 or the Russell 3000. Because they aren’t constantly buying and selling assets to change their portfolio in an attempt to beat the market, passive funds offer lower costs than active funds. But passive funds are also derided by many fund managers as a way to guarantee mediocrity, as they will “only” do as well as markets. That’s why many investment professionals will recommend active funds, so that investors can outperform markets. But will investors who invest in active funds actually beat markets?
A recent report published by S&P Dow Jones Indices indicated that passive funds may actually outperform active funds by quite a wide margin. When comparing active fund performance to the benchmark indexes those funds were attempting to outperform, S&P found that most active funds were outperformed by the benchmarks. Out of all domestic equity funds, over 63% were outperformed over the past year.
And those number just get worse as time progresses. At the 3-year, 5-year, 10-year, and 15-year marks, that number increases to 83.40%, 86.72%, 86.65%, and 83.74% respectively. And those numbers are even worse when you look at small-, mid-, and large-cap funds. Over a fifteen-year period, 92-96% of those active funds are outperformed by benchmarks.
That means that at best you can expect a less than 20% chance of outperforming markets by investing in an actively-managed fund, and at worst a 4% chance of outperforming markets. And for that you get the privilege of having to pay higher fees to boot. With that kind of performance, it’s no wonder that more and more investors are choosing to invest in passive index funds.