Index funds are never out of style
Actively managed stock mutual funds have outperformed the major stock indexes for an entire decade - but don't ditch your index funds just yet.
The average diversified U.S. stock fund gained an average 6.7 percent a year over the past 10 years, according to Lipper, which tracks the funds. By comparison, the Standard & Poor's 500-stock index rose an average 5.9 percent a year, assuming dividends were reinvested. And the more broadly based DJ Wilshire 5000 was up an average of 6.3 percent a year.
In theory, index funds will surpass average actively managed stock funds in the long run. After all, managed funds typically must keep part of their portfolios in cash to meet redemptions. In addition, all mutual funds use part of their gains to pay costs, which stock indexes don't.
And indeed for much of the past two decades, indexes have clobbered the average stock fund. For the 10 years that ended in 1997, the average stock fund gained an average 16.2 percent a year, versus 18.0 percent for the S&P 500 and 17.6 percent for the DJ Wilshire 5000.
Over the years, as actively managed funds continued to trail the indexes, investors poured billions into the low-cost funds that simply track an index. The Vanguard 500 Index fund, which tracks the S&P 500, is the third-largest stock fund in the United States. The SPDR Trust, an exchange-traded fund that also tracks the S&P, is the largest U.S. exchange-traded fund.
So why was the past decade so kind to managed funds? The reason is small-company stocks. The S&P 500 gauges the performance of large-company stocks. And the DJ Wilshire gives more weight to larger stocks. So it, too, is dominated by large-company stocks.
But the figure for the average U.S. stock fund includes small, midcap and large-company stock funds. And the average small-company fund has soared an average 8.1 percent a year for the past decade.
"Small-cap and value funds have been the big winners," says Tom Roseen, senior analyst for Lipper.
In addition, truly terrible funds simply go out of business, and their records vanish. The figure for the average stock fund measures only those funds whose records were good enough to survive. And plenty of terrible funds have perished in the past decade.
If you're going to compare any funds to the indexes, Roseen says, compare large-company funds. And there, by contrast, actively managed funds don't hold up well. The average large-company stock fund has gained just 5.0 percent a year in the past decade - well behind the S&P 500 and the DJ Wilshire 5000.
After the first week of 2008, though, investors might not be interested in stock funds of "any "kind. The stock market suffered one of the worst opening weeks ever. The S&P 500 plunged 3.9 percent in three trading days.
WBJ Web Partners
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