March 09, 2009
Index Funds Win Again
Here’s yet another piece that touts the advantages of index funds — this time from the NY Times. The conclusion:
There’s yet more evidence that it makes sense to invest in simple, plain-vanilla index funds, whose low fees often lead to better net returns than hedge funds and actively managed mutual funds with more impressive performance numbers.
Basic stock market index funds generally aspire to nothing more than matching the returns of a market benchmark. So in a miserable year for stocks, index funds may not look very appealing. But it turns out that, after fees and taxes, it is the extremely rare actively managed fund or hedge fund that does better than a simple index fund.
The piece goes on to detail the work and findings of Mark Kritzman, president and chief executive of Windham Capital Management of Boston and professor of financial engineering at M.I.T.’s Sloan School of Management, where he compared index funds to actively managed funds and hedge funds. The simplified summary: actively managed funds perform better before expenses are subtracted. But once expenses are deducted, index funds are the better choice. Their words:
Expenses were the culprit. For both the actively managed fund and the hedge fund, those expenses more than ate up the large amounts — 3.5 and 9 percentage points a year, respectively — by which they beat the index fund before expenses.
If such outperformance isn’t enough to overcome the drag of expenses, what would do the trick? Mr. Kritzman calculates that just to break even with the index fund, net of all expenses, the actively managed fund would have to outperform it by an average of 4.3 percentage points a year on a pre-expense basis. For the hedge fund, that margin would have to be 10 points a year.
As I’ve said before (probably a hundred times now on this site), costs matter BIG TIME when it comes to investment returns (that’s why I’ve taken extra steps to get my investing costs as low as possible.) And that’s one reason I like index funds — they keep investment costs to a minimum and thus keep total returns as high as possible.
For more thoughts on index funds, see these posts: