Investing in investment funds that follow the market, also called passive investing, is considered boring.
But the truth is in the returns: index funds routinely beat funds actively managed by professional stock pickers.
Last year was no exception, according to a new BofA Global Research report. Funds managed by the pros managed to beat the returns of passive indices that track large-cap U.S. stocks.
For example, only 36% of actively managed U.S. large-cap mutual funds posted greater gains than their Russell 1000 index benchmarks in 2024.
To be fair, the Russell 1000, a stock index that provides exposure to companies like Apple, Nvidia, Microsoft, Amazon and Facebook parent company Meta, had a lot of influence on these popular tech stocks.
But it’s no coincidence. Of the more than 1,900 U.S. stock funds and ETFs tracked by Morningstar, 19% beat the S&P 500, which returned 25%, and only 37% beat their category index in 2024.
For twenty years, S&P Dow Jones Indices has produced “scorecards” that compare the performance of actively managed equity and fixed income mutual funds against various indices over different time periods. For example, over the past three years, 86% of actively managed funds failed to match the S&P 500. Over a ten-year period, 85% of these funds performed worse than the S&P 500, according to the data.
One superstar who admires low-cost index funds is Warren Buffett.
“In my opinion, the best thing for most people is to own the S&P 500 index fund,” Buffett said at a Berkshire Hathaway annual shareholder meeting a few years ago.
“People will try to sell you other things because there’s more money in it for them. And I’m not saying that’s a conscious act on their part. Most good salespeople believe in their own bullshit… that’s why I suggest for people they buy an index fund.”
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Berkshire Hathaway CEO Warren Buffett drives through the exhibit hall during the company’s annual meeting in Omaha, Nebraska, on April 29, 2022. REUTERS/Scott Morgan ·REUTERS/Reuters
I’m a firm believer in investing my retirement savings in index funds because it’s simple and cheaper than picking individual stocks and bonds to buy and sell at the perfect time.
And you’ll likely get out of trouble in the stock market if you stay the course in diversified baskets of stocks and bonds.
Sure, it looks more like a gentle twist on a teacup at Disney World’s Mad Tea Party than Six Flags’ Maxx Force, but for most of us, this is the ticket to ride.
Investors who choose actively managed mutual funds tend to pay higher fees than passive investors, which is a headache given the imbalance in performance.
It’s also perfect to call investing in index funds passive, since the purpose of owning them is to cool your planes when the markets get dirty.
Investing in index funds – evenly split between stocks, such as the S&P 500 index, and fixed-income bond funds and put on autopilot – has been classic advice for many investors, especially those ditching retirement funds. And if you’re already retired, managing costs helps increase net returns.
“I anchor clients’ investments in a passive index strategy because history continues to prove that passive investments outperform active managers over time,” Lazetta Rainey Braxton, a financial planner and founder of The Real Wealth Coterie, told Yahoo Finance . “Objectives are consistently achieved on an investment basis, without the added risk associated with monitoring and following active managers who can earn that extra return after their fees.”
Although fees have fallen in recent years, index equity mutual funds had an asset-weighted average expense ratio of 0.05% in 2023, compared to 0.42% for actively managed equity mutual funds, according to research from the Investment Company Institute (ICI). funds.
Index funds are in fashion these days. About 52.6% of mutual fund and ETF assets were in passive funds at the end of November, up from 49.6% in November 2023, according to research and advisory firm Cerulli Associates.
One big driving force behind the move to index funds: an increase in investing in target-date funds.
I suspect many of you already invest in index funds in your employer-provided retirement plans, such as your 401(k). Virtually all 401(k) plan sponsors and the majority of state auto-IRA programs use target date funds when they automatically enroll employees in a retirement plan.
These funds typically consist of index funds.
With a pension fund with a target date, you select the year in which you want to retire and buy an investment fund with that year in its name (such as Doel 2044). The fund manager then divides your investment between shares and bonds, adjusting it to a more conservative mix as the target date approaches.
At Vanguard, for example, 83% of 401(k) participants were using target-date funds, and 70% of target-date investors had their entire account invested in a single target-date fund. That’s up from 6 in 10 in 2022, and more than double the figure in 2013, according to Vanguard.
“The passive approach has been proven to work,” Zaneilia Harris, financial planner and president of Harris & Harris Wealth Management Group, told Yahoo Finance. (Photo courtesy of Zaneilia Harris)
I reached out to financial advisors to get their opinions on the role index funds should play in retirement accounts. Here’s why they love it too:
“The passive approach has been proven to work because of consistency, increasing contributions, time and compound interest,” Zaneilia Harris, a financial planner and president of Harris & Harris Wealth Management Group, told Yahoo Finance.
“John Bogle, the grandfather of passive investing, advocated keeping it simple, easy and cost-efficient,” she said.
But she also advises her customers to add some juice. “Some investors may take a more strategic approach to growing their retirement savings, such as adding a handful of individual stocks,” Harris said.
For Leo Chubinishvili, a financial planner at Access Wealth, it’s all about the underlying costs. “Cost efficiency – passive funds, such as index funds, have lower expense ratios compared to actively managed funds,” he told Yahoo Finance. “Cost savings result over time, which benefits retirement savers. And passive investments could reduce the temptation to make frequent adjustments based on market volatility.”
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(Getty Creative) ·skynesher via Getty Images
For current retirees, index funds make sense for a few key reasons, Christine Benz, director of personal finance at Morningstar, tells Yahoo Finance.
“Managing a streamlined investment portfolio is important at any age, but it is especially useful as we get older. Index funds give you broad market exposure in a simple package. With broad market index funds, you don’t have to worry about management or portfolio changes, and it’s also a breeze to see if a rebalance is appropriate and where to do it.”
She added: “Reducing the moving parts in your portfolio will make life easier for your loved ones if they need to manage your finances at any time.”
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The tax benefits are another major reason why these are attractive to retirees. Index fund portfolios (especially ETF portfolios) tend to have low tax costs, especially on the stock side, Benz said.
“Given that many investors’ portfolios peak at retirement and include a significant portion of taxable, non-retirement assets, reducing the tax burden is another way to increase net returns,” she says.
One caveat: “Passive is cheaper than active management and it does very well in a bull market,” says Cary Carbonaro, managing advisor at Ashton Thomas. “It’s in a bear market where it may not perform as well.”
Kerry Hannon is a senior columnist at Yahoo Finance. She is a career and retirement strategist and author of fourteen books, including ‘In control at 50+: how to succeed in the new world of work” and “Never too old to get rich.” Follow her further Blue sky.
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