NCPA - National Center for Policy Analysis

Index Funds Outperform Managed Funds

February 21, 2002

Investors can put their retirement savings into index funds, whose returns track an average of major corporations' stocks, or for fees they can put their money in managed funds. In recent years, some managed funds have outperformed stock index funds. In 1999 and 2000, for example, the average managed domestic equity (stock) fund beat S&P 500 index of major corporations' stocks by 8.77 percent and 9 percent respectively. However, over the long-term, index funds beat the best managed funds.

Morningstar, the research firm, divides the managed funds into sectors by the type of stocks they hold: large, medium and small capitalization stocks, then growth, blend and value stocks. In any period, one sector can do better than another. For instance:

  • Last year, small value funds had an average return of 17.28 percent.
  • Large growth funds lost 23.6 percent of their value --making the difference between the two sectors a whopping 40 percent.
  • Given such figures, there ought to be a long-term advantage to owning a particular sector -- and not worrying about paying the 2 or 3 percent management fee.

However, as financial journalist Scott Burns explains, it doesn't work out that way.

  • Over a five to 10 year period, the spread between the best and worst of the sectors is less than 4 percent -- and at 15 years less than 1 percent.
  • That is less than the premium paid to a fund manager.
  • Meanwhile, the Vanguard 500 Index fund beat all 9 sectors over the last 15 years, trumping the best by nearly 1 percent

The index, however imperfect, captures most of the market capitalization in the U.S. market. While some stocks drop others rise. Entire industries can decline, but the index will still perform relatively well.

Source: Scott Burns, "Go Index Funds for the Long Term," Dallas Morning News, February 12, 2002.


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