Index funds
These are mutual funds, exchange-traded funds or unit investment trusts designed to track the returns of a market index. The index referred to is a combination of securities representative of a particular section or whole of the market concerned. The market can be a stock market or a bond market. Investment in index funds amounts to passive investing. This is so as the portfolio manager only replicates the existing index without taking into account his or her views. Such index funds include Standard & Poor’s 500, Rusell 2000, Doe Jones Wilshire 5000 and Vanguard (Graham 54).
Actively-managed funds
This is a mutual fund in which the portfolio manager strives to outdo the market by selecting the best investment. The manager has to conduct a detailed analysis of the varied investment in the market. Based on the results, the manager seeks to secure the best returns from the funds appropriately.
Comparison of index funds and Actively-managed funds
Actively-managed funds have the potential to outdo the market in terms of performance unlike their counterpart, the index funds. This serves as the most attractive feature to potential investors. The goal of any investor is to maximize their returns in any particular investment. Settling for the index fund implies receiving a market return that is less the manger’s remuneration. On the other hand, chances of the actively-managed funds outperforming their assigned index are rare. For instance, according to statistics from the Vanguard Company, a large number of the U.S securities failed in their goal to outperform the index they wished to outdo in the last decade. In addition, it is a daunting task for the investor to correctly identify the fund that will attract more returns relative to the index.
Certain funds might manage to beat their relevant indexes and may easily lure investors into purchasing the actively-managed funds. However, the reasons for these could be excellent skills of the manager concerned or pure luck. Based on statistics from the Barclays Global Investors, chances of an actively-managed fund’s continued out-performance of the index are very slim. In terms of cost, the actively-managed funds have an initial disadvantage over the index funds. The subsequent average cost of management of the actively-managed funds is one percent more than that of the index funds. This is another reason for the under-performance of the actively-managed funds relative to their index.
Similarly, the tax imposed greatly influences the performance of the two funds. Though not often depicted in the return figures, the portfolio manager is bound to buy and sell various investments in the search for more returns. In the process, the purchase and sales activities are referred to as turnover. So long as the account in question is not a retirement account, these are taxable capital gains. This again increases the expenses on the actively-managed fund (Graham 30).
Therefore, due to the cost, tax and other expenses associated with the actively-managed fund, the eventual return form it is greatly reduced. However, one can secure the service of a skilled portfolio manager in an attempt to try and achieve better returns. Even in such situations, uncertainty about the performance of the actively-managed fund still exists. Due to this, the index fund may be the best choice of the two. It requires no monitoring and has fewer costs.
Works Cited
Graham, Benjamin. The Intelligent Investor. New York: HarperBusiness Book, 1984. Print.