Earlier this week I was a guest on The Money Show with Bill Moller on a local radio station. The topic was mutual funds and the differences between actively managed, index funds and exchange traded funds.
As my clients know I am a big advocate of index funds and exchange traded funds. Here are the key advantages of an index fund or an exchange traded fund. In a future blog I will discuss which types of index and exchange traded funds I favor.
Low Fees: Most index funds charge management fees of less than 0.5% per year. Actively managed funds often charge fees of about 1.5% year. Over time that difference really affects performance.
Tax Efficiency: Since index funds do not actively change the stocks that they hold they generate much lower capital gains distributions than most actively managed funds. That means that more of the capital gain on an index fund will be deferred and working for you rather than in the pocket of the US Treasury.
No Style Creep: Because of the nature of an index, Index funds cannot change the types of stocks they invest in. For example, an S&P 500 index fund will always invest in Large Cap US based companies. However, actively managed funds sometimes shift their composition (a large cap fund buying small cap stocks) to attempt to improve their performance. This practice makes it difficult for investors to know what type of fund they own.
According to research by Standard and Poors published in the Chicago Tribune, over the last 5 years the S&P 500 Index outperformed 71.4% of actively managed large cap funds, the S&P MidCap Index 400 outperformed 79.7% of mid-cap funds, and the S&P SmallCap 600 Index outperformed 77.5% of small cap funds.
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[...] I wrote about the advantages of index funds a few years ago I left one out: Because index funds don’t trade as often they generate much [...]