The argument against passive investing

On a message board I frequent, there was recently a question about mutual funds. Which should I invest in? Large cap? Mid cap? Small cap?

I said:

“Index fund investing”

Index funds are the way to go. Actively managed funds (like all those mid-cap growth, large-cap blend funds) do not beat the indexes over time, and are more expensive to invest in. I suggest Vanguard 500 index fund. You may want to supplement that with REITs, metals, and bonds.

Someone disagreed, arguing that we pay to beat the market, not match it, and that TRMCX has done just that since he bought it. And it’s up 10% this year vs. 3% for the S&P (tracked by VFINX). There was a link to the quote for TRMCX titled “A litle research can be a dangerous thing”.

MY reply:

“A little dangerous research”

Take a look at a ten year chart of the Dow, the Nasdaq, the S&P 500, and TRMCX. Of course your fund hasn’t been around ten years, but close (1996).

TRMCX has gotten lucky the past few years. So has just about every other small and mid cap fund. Mid caps won’t always outperform the market (look at the ten year chart).

Now consider cost: over ten years 10,000 in your actively mnagaed fun will cost you $1,120 (0.91% expense ratio). In my VFINX that same investment will cost you $230 (0.18% expense ratio).

Now consider the odds. Can you name one actively mangaed fund that beats the market all the time? TRMCX has been lucky since just before 2001. Prior to that TRMCX underperformed. It was beaten badly by the index from its inception until late 2000. Actively managed funds underperform sometimes, but they always cost more.

I know that sometimes actively managed funds beat the index. But you never know which ones are going to beat the indexes, when, or for how long.

2 Responses to “The argument against passive investing”

  1. vrtourist says:

    I could not agree with you more! There are good fund managers but than keep track of them can be a challenge. The fund never tells you the manager has changed. And investing in a good performance fund with the original portfolio manager gone is also a danger. Index does not have to be market performance. I have known idex funds out performing the index by a large statistical margin. They over weight to the good and under weight the bad. You can identify a good handful of bad companies in the index and good companies in the index. The question is now “are you an index fund?”

    Cheers,
    Val

  2. James Trotta says:

    Which index funds outperform the index? I thought index funds were supposed ot match the index…