Index Funds

Most investors expect professional investment managers such as those managing mutual funds to outperform the stock market. However, this is seldom the case. Mutual funds rarely beat the stock market benchmarks such as the S&P 500, an index of the share of 500 large US companies. After all if the investment managers who work round the clock on choosing the right investments don't outperform the stock market, why pay extra money to buy into their mutual funds? Isn't it best to invest in index funds?

Research has shown that the majority of stock investment managers lagged the stock market in 12 out of 20 years from 1976 to 1995. Moreover, more than half of stock mutual funds managers have fallen short of the stock market 's average return over longer periods as well. For example, less than 20% of the 402 US diversified mutual funds that had been around for the 10 years managed to beat the S&P 500 's 14% annual return for the 10 years to April 1, 1996.

The reason most mutual funds don't outperform the stock market averages is because the professional investment managers at mutual funds, banks, insurance companies, etc are the market. The portfolios they manage account for half the value of US stocks and account for the bulk of the trading in those stocks. Therefore, their investment returns are the stock market returns. There are also mutual funds annual operating expenses. When you deduct mutual funds expenses, you are further away from stock market averages.

How did investment managers beat the stock market in some years?

Nearly 87% of all  investment managers beat the stock market performance in 1977. Many stock mutual funds that outperformed the stock market (such as the S&P 500) invest in smaller cap stocks when small cap stocks are performing well, better than large cap stocks. These small cap stocks are smaller than those in the S&P 500.

• When to invest in Index Funds