Two recent news stories focused on one of the more divisive debates in retirement savings: Invest in actively managed funds or passive, indexed funds?
The Wall Street Journal noted that for the first time in several years actively managed equity mutual funds have outperformed their indexed or passively managed peers in 2015. Specifically, the average actively managed U.S. stock funds rose 2.25 percent compared to a 2.2 percent increase for indexed funds through the end of April, according to Morningstar, the investment data firm. The S&P 500 index rose by 1.9 percent.
Points for active management? Not really. Bloomberg Business looked at the results of a Bloomberg Markets Global poll of finance professionals. One question was: "What do you think is most appropriate for someone who is mid-career and trying to save for retirement?" Among U.S. respondents, 52 percent favored index funds and exchange traded funds.
The professionals know it's hard to systematically outperform the market. Instead, build the core of your retirement portfolio around broad-based low-cost index funds. You'll do as well and as poorly as the market index. You should broadly diversify since no one really knows which assets will zig and which will zag.
Of course, there are times — like now — when active managers in the aggregate do well. The case for indexing grows stronger with time. Passive portfolios that held all the stocks in a broad-based market index substantially outperformed the average active manager since 1980, calculates Burton Malkiel, author of "A Random Walk Down Wall Street."
Fees are a major reason why well-designed index funds do well. Actively managed mutual funds cost more, with fees typically in the 0.6 percent to 1 percent range compared to lows of 0.1 percent to 0.2 percent with index funds.
A simple example: Invest $10,000 and earn a 7 percent average annual return over 30 years. At a 0.89 percent annual fee your $10,000 is worth more than $58,000. The same investment at a 0.12 percent fee? It's worth over $73,000.
Indexing is part of a larger strategy: Keeping it simple. The risks and rewards of simple investments are easier to grasp and monitor. The expenses are low. Less money paid to professionals is more money in your pocket.
Chris Farrell is senior economics contributor, Marketplace, and economics commentator, Minnesota Public Radio.
