Investing in your retirement
In the end, all that activity often doesn't guarantee top returns.
It's not that fund managers
aren't smart enough to beat the indices. But
in general, most actively managed funds come
with higher annual expenses that eat into
performance and profits, making it difficult
to beat index funds. Over the past 10 years,
the cheapest S&P 500 index funds beat more
than 60 percent of their large-cap blend peers,
according to Morningstar.
As an example, the expense ratio
for large-blend index funds averages 0.59
percent, but the annual expense ratio for
an actively managed large-blend fund typically
runs 1.22 percent, according to Morningstar.
That may not sound significant,
but don't be fooled. A seemingly small difference
in expenses can be worth a small fortune over
Imagine two investors with $10,000
each and deep convictions about how to invest
their money. One puts his money in an index
fund that returns 10 percent minus 0.20 percent
in expenses. The other invests in an actively
managed fund that also returns 10 percent
annually but has an expense ratio of 1.22
percent. Both leave money in their respective
funds for 35 years.
- The index fund is worth $263,683
after 35 years.
- The actively managed fund
is worth $190,203 after 35 years.
- The difference is $73,480.
Taxes are another consideration.
Remember, Uncle Sam wants his piece of the
action when you sell winning investments.
Because actively managed funds reshuffle their
stock holdings far more frequently than index
funds, they trigger more taxes than index
funds, which have a buy-and-hold approach.
The bottom line: With their
low costs and generally higher returns, index
funds usually are the best bet for most investors.
Mutual funds have their limitations. For starters,
the actively managed variety passes on to
investors the overhead costs (research and
management expenses), which eat away at returns.
Funds also distribute capital
gains at the end of each year, a taxable event
for shareholders -- even in years with negative
returns. This is true of both actively managed
and index funds, though the latter are more
And, because they get priced once daily at the close of the trading day, funds aren't flexible enough for investors who wish to take advantage of short-term dips and spikes in the market through intraday trading.
Enter the more sophisticated exchange-traded
fund, or ETF, which arrived on the scene in
1993 and has fast become the investment tool
of choice for Wall Street and Main Street