Imagine yourself suddenly
dropped into the center of your hometown after
a lengthy absence. You have 20 minutes to
get to the airport, far out in the suburbs.
Would you prefer to drive yourself, given
your extensive, though not recent, knowledge
of the back roads and shortcuts of your birthplace?
Or would you rather take a taxi, figuring
the driver may be more informed on routes,
road closures and detours?
Investors face a similar head-scratcher when it comes to choosing
between the index (or passive) mutual funds you drive and actively
managed (or active) funds that leave the driving to others. Both
can get you where you want to go -- a financially sound retirement
-- but chances are you'll prefer one ride to the other.
"There's just not a one-size-fits-all portfolio or rule of thumb," says Sonya Morris, fund analyst for Morningstar. "It's going to depend on the investor's risk tolerance, objectives and time horizon."
The debate over index vs. actively
managed funds has raged so long without resolution
that it has taken on the rich patina of the
great sports rivalries. As with all great
rivalries, both sides are somewhat evenly
matched, have their unique strengths and weaknesses,
and prevail and disappoint in about equal
|Index vs. active funds
Get your pencils and scorecards
ready. Here are the team lineups:
Index funds invest in equity or fixed-income
securities specifically to replicate indexes
such as the Standard & Poor's 500 or Lehman
Brothers U.S. Aggregate. Index funds are recommended
as solid, long-term core investments.
Strengths: Because the holdings in these funds are closely
tied to their respective indices, there is
little in the way of buying and selling (called
"turnover") or management involved,
resulting in minimal cost to investors. For
example, the popular Vanguard 500 Index fund
charges only 18 basis points (0.18 percent)
in fees. Index funds also are well-diversified
and easy for even a novice investor to purchase.
Weaknesses: Because index funds by nature do not correct for market conditions, they passively go in the direction of the market, both up and down. This can sometimes try the patience of investors, particularly during periods of volatility.
Some financial advisers, including "Die Broke"
Pollan, find index funds safe but pretty
"Index funds do not have the advantage of having stocks picked for quality, for performance at the time," he says. "Bringing this down to basics, index funds are cheaper but you're missing good judgment."