Passive funds outperformed actively managed mutual funds over past decade

By BenefitsPro

By Paula Aven Gladych

The majority of actively managed mutual funds failed to outperform the market index over the last 10 years, according to a new study by InvestingNerd.

Only 24 percent of professional investors were able to beat the market over this period. Because of high fees paid to professional fund managers, most investors won’t outperform passive indexes, the study found.

Despite studies showing this, investors continue to pay for active asset management, preferring to try to pick a winner rather than playing it safe. As of Dec. 31, 2012, there was more than $7 trillion invested in more than 23,000 actively managed mutual funds and exchanged-traded funds, almost three times the $2.5 trillion invested in passive funds.

NerdWallet examined the actual outcomes over the past decade of investing with active versus passive management. The study looked at more than 24,000 mutual funds and ETFs available to U.S. investors for the 10-year period ending on Dec. 31, 2012. Of these, only 7,943 were in existence for the full 10 years.

The asset-weighted average return of the actively managed mutual funds over this period was 6.50 percent while the passively managed index products averaged 7.30 percent. Similarly, for equity funds the average return was 7.19 percent for active managers and 7.65 percent for passive funds. Index funds outperformed actively managed funds regardless of whether returns were measured by asset-weighted average, median, or a simple average.

The study also found that index funds outperform actively managed funds by 0.80 percent annually, but active managers have lower risk.

“It’s critical that when investors are choosing between mutual funds, they not concentrate solely on past returns but look at the big picture and consider expense ratios, a fund’s strategy, and potential for losses. This is why we have created a comprehensive tool that screens and ranks funds based on these factors for investors looking to make better decisions,” says Joanna Pratt, vice president of financial markets at NerdWallet.

Active managers actually outperform the index by 0.12 percent before fees, but charge more in fees than the value they create.

Large funds significantly outperform small funds with much higher returns and lower risk and smaller stocks are riskier than large stocks, but don’t necessarily deliver higher return.

Growth stocks significantly outperformed value stocks over the past decade, as well, researchers said.

InvestingNerd is a division of NerdWallet, a personal finance website that helps consumers save money and make better financial decisions.

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