This graph is based on the data collected in the course of twenty years, from 1986 to 2006. It indicates that on average only thirty percent of actively managed equity funds can outperform Vanguard 500 Index Fund or S&P. The key advantage of index funds is that they enable to diversify the investment and reduce the risks to a minimum (Ross et al, 2011). However, their return on equity may be lower than that one of actively managed funds. This is one of the issues that should be taken into account.
This information has significant implications for the investors. If they want to maximize their profits, they may give preference to actively managed funds since in this way they will be able to choose some specific companies and invest money in them. However, if their primary concern is safety and stability, they should choose index funds. In other words, the choice between these two options depends on the investor’s ability to take risks.
Additionally, if we take a look at the period between, 1999 and 2006, we can argue that the efficiency of mutual funds has increased and during that time investments in separate companies were yielded more income. Yet, this graph does contain data about the next four years during which the stock value of many separate companies significantly declined while index funds were less affected by the economic downturn. This is the key benefit of adopting this approach.
It is necessary to discuss this graph in connection with efficient market hypothesis, according to which the present value of a stock reflects all the information about the company (Madura, 2008 p 287). In other words, a person cannot maximize his or her profits on the basis of data that is available only to him or her. Overall, this theory postulates that it is impossible to predict the changes in the value of a stock.
This graph is partially consistent with this theory; it confirms only semi-strong form of this hypothesis, which means that the value of an asset reflects mostly public information rather than insider information (Madura, 2008 p 287). Judging from this graph, we can argue that modern investors can significantly maximize their profits only if they have access to certain very confidential data which is not readily available to the public. Naturally, one cannot deny the effect that efficient market hypothesis is often disputed and even criticized, but it still remains at the core of financial science.
Therefore, if I were to make a decision about the equity portion of my 401 (K) account, I would certainly try invest money in index fund, like Vanguard 500 Index Fund. The thing is that 401 (k) is a form of retirement savings and under such circumstances, a person should avoid risk-taking. By investing into index funds, one can ensure that this investment will continuously generate income in the long term. Certain, I could invest company into the stocks of three or four companies, if I had access to some hidden and verified information about these organizations. Yet, I do not have access to these data. Again, I am not in the position when I can afford to take risks. On the whole, this choice much depends on the financial capabilities of investors and their knowledge of different industries and markets.
Reference List
Madura J. (2008) Financial markets and institutions. NY: Cengage Learning.
Ross, S., & Westerfield, R., Jaffe, J., & Jordan, B. (2011). Corporate finance: Core principles and applications (3rd ed.). Boston, MD.