Index funds vs. actively managed funds | Vanguard (2024)

FAQs

Index funds vs. actively managed funds | Vanguard? ›

Index mutual funds and ETFs (exchange-traded funds) aim to match the performance of a particular market benchmark—or "index"—as closely as possible. Actively managed funds employ professional management teams who try to outperform their benchmarks and peer-group averages.

This is because index funds do not incur the costs associated with active management, such as research expenses and high portfolio turnover. With lower expenses, index funds provide a cost-effective option for investors seeking broad market exposure.

According to data from Morningstar Direct, just 18.2% of actively managed funds whose primary prospectus benchmark is the S&P 500 managed to outperform the index in the first half of this year.

Buffett's rationale behind endorsing S&P 500 index funds is rooted in their simplicity and effectiveness. He argues that attempting to outperform the market is futile for most investors, and instead, they should seek exposure to the broad U.S. stock market through low-cost index funds.

As a result, the percentage of actively-managed mutual funds that outperform the S&P 500 in any given year is only around 40%. And very few can consistently beat the market by enough every year to come out ahead in the long run.

Over the past decade, an annual average of only 27.1% of actively managed funds benchmarked to the S&P 500 beat it. There are a few reasons why stock pickers are stinking up the joint worse than they normally do.

Index funds have lower expense ratios than most actively managed funds, and they often outperform them, too. These reasons make them a solid choice not only for beginners but for many expert investors as well.

Most advisors do not beat market averages. There are popular index funds that track indices, such as the S&P 500, and a little over 80% of the time advisors and even actual mutual fund managers do not beat these taking 15 years into consideration.

It's quite possible that you don't have the risk tolerance that's needed to even invest in an S&P 500 index fund. If this is the case, then you shouldn't bust your advisor's chops if he/she can't beat the index, because in this instance, the index has a different risk level.

What is the 90 10 investment rule? ›

According to Buffett, you should invest 90% of your retirement funds in stock-based index funds. According to Buffett, the remaining 10% should be invested in short-term government bonds. The government uses these to finance its projects.

The foundation of your portfolio should be low-cost, diversified equity and fixed income index funds. For U.S. equities, target funds tracking the S&P 500 or total U.S. stock market. In terms of allocation, a reasonable starting point may be60% equities and 40% fixed income.

This investment strategy seeks total return through exposure to a diversified portfolio of primarily equity, and to a lesser extent, fixed income asset classes with a target allocation of 70% equities and 30% fixed income. Target allocations can vary +/-5%.

Morningstar found that from 2014 to 2023, just one in every four active funds beat its average indexed peer. And index funds dominated active funds in the largest categories. The U.S. large-blend category represents about 27% of the U.S. mutual fund and ETF market.

Vanguard Growth & Income Fund (VGIAX)

VGIAX's one-two punch of investment goals helped it beat the overall stock market in 2022 and 2023. Over the past 10 years, this fund's average annual return beats the S&P 500's by a nose.

On average, active equity funds fail to meet their benchmarks, which suggests that investors should avoid them in favor of low-cost index funds.

Index funds are generally suitable for risk-averse investors because of their diversified nature and lower volatility. Conversely, with their active management, mutual funds can be more volatile but also offer the potential for higher returns, making them suitable for risk-tolerant investors.

Index funds are designed to keep pace with market returns because they try to mirror certain market segments.

Exchange-traded funds (ETFs) and index funds are similar in many ways but ETFs are considered to be more convenient to enter or exit. They can be traded more easily than index funds and traditional mutual funds, similar to how common stocks are traded on a stock exchange.