Financial Question Of The Day: Do you prefer index funds or mutual funds?

Do You prefer investing with index funds or mutual funds?

Some of you might not have an opinion about this, either because you haven’t started to seriously invest, or you’re not financially nerdy enough to care. But, I’ve found that personal finance advisors and bloggers differ quite a bit on this issue.

Personally, I continue to invest in growth stock mutual funds. I like small and mid cap mutual funds that focus on smaller companies with a high potential of growth. One of the biggest criticisms about mutual funds is that the fees take away from the large gains they make, and don’t make it worth it in the long run. This may be true to some extent, but I can’t get past the fact that I can find mutual funds with track records of 13 to 15% over a 10 year period, versus index funds which follow the stock indexes that tend to average 8 to 10 percent. I want to know your take about index funds versus mutual funds.

  • J

    The answer is index funds, and it’s not even close.

    If you don’t know why, you shouldn’t be investing.

  • Danny Tsang

    I would normally say index funds like most other bloggers..but I’m starting to lean towards mutual funds with good investment philosophies. The reason is because I don’t think the stock market will behave like it has for the past 3 decades. We’ve had a lot of booms and even Warren Buffett thinks those times are past us. So, for our generations it may be wiser to invest in funds that employ good managers to actually analyze data and make good decisions. I think market returns will be 6-7% annually max here on out. It can’t just keep going up forever. At some time, some one (like a manager) needs to spot undervalued funds and buy them, while selling off the bad stuff.

  • author

    J, there are plenty of wise fund managers out there with low fees that beat the pants off of index funds.

    why don’t you enlighten us as to why we shouldn’t invest if we don’t know why index funds are so much better.

  • J

    A simple google search on “index funds” should provide all the evidence you need.

    Or search on Amazon for “John Bogle”.

    The onus on proof is on the non-indexer. Name some managers that have “beaten the pants off” the indexes for 20+ years.

  • J

    I’ll add this … you’ll get MUCH more out of an investment plan that focuses on finding an asset allocation that fits your financial goals and risk tolerance, and the simply putting that asset allocation into action using low cost index funds with track records spanning 100+ years.

    Do this instead of searching for “top managers” of active funds in each asset class hoping that they weren’t a flash in the pan, and hoping that they even stay on the job long enough to make a difference for you.

    Asset allocation is the investment strategy that pays off in the long term … not finding hot stock or bond pickers and constantly checking in to see if they stay hot.

    Seriously, I thought this ship had already sailed in the “Personal Finance” community.

  • J

    To clarify, my reference to “100+ years” is in reference to the track record of general stock and bond market performance (that is, the performance index funds mimic), and not the individual index funds themselves of course.

  • ekrabs

    First, let me state outright that I am a fan of John “Jack” Bogle, so there’s no misunderstanding about my personal biases.

    There are plenty of funds out there have can beat the market at any one time… but very, very few of them are capable of doing so on a consistent basis. In fact, the only claim to such a fame was Bill Miller of Legg Mason Capital Management, who HAD a 14 year streak of beating the market.

    The argument that one can find funds with returns of, say 13% to 15%, are unfortunately based on PAST performances, and PAST performances are no guarantee or indication of FUTURE performances. To see why that is a topic beyond the scope of this response… but for the keen investor, it is still a worthwhile endeavor.

    In fact, I can even say that my international fund performed rather well in the past few years, average around 25% to 30%. So, does that mean that I should throw all my money into that international fund? Well, if my year to date’s performance is any indication (of -7%), I would venture to say NO.

    Please don’t get me wrong though. I am what in my circle would call “weapon agnostic”. As in, I do what makes the most sense to me, giving my current personal financial situation rather than what I think is better. For example, there are places for managed funds as well as index funds just as there are places for a hammer and a screwdriver. To me, it seems futile to debate whether one tool is better than the other. Not everything requires a hammer, and heaven help you if that’s all you believe in….

    So, in practice, I actually do a bit of both, depending on what appears to work best for my own portfolio. However, for the average investor starting out, I would most definitely recommend index funds to start out, if there is a choice. In fact, I recommend to read “The Bogleheads’ Guide to Investing” for everyone who wants to get into investing!

    There’s much more to be said about this and related subjects, but I think this will do for now eh?

  • Mitch Tuchman

    The question is really not framed correctly. Its not about picking a mutual fund over an index fund. Rather its about thinking you can “pick” good managers (or stocks for that matter) as a way to boost investment returns. This is not what accounts for 90% of investment returns. In fact, its asset allocation which means — “where do you have your $ invested?” If you are in gold and gold mining stocks this year, you’re up 20% regardless of your picks. If you own GDX (index fund) or BGEIX (mutual fund) — they’re both up the same. The real way to make money is to focus on which asset class and THEN use low cost index funds to get that exposure. So what is your % in US stocks right now? Foreign stocks? Real Estate? And why? The joke is that Wall Street gets us all focused on stock picking and market timing and therefore we think about mutual funds vs index funds. This is the wrong way to think.

  • Greatest Blogs And Websites

    I would not go for either one. I like exchange traded funds. Because you have the ability to focus on a narror sector like steel coal or single country fund. Theirs dozens of single country and dozens of narrow sector funds. So theirs always something much out of favor that you can buy at a great price.

  • Dennis The Menace

    Exchange traded funds are better because you are buying a basket of stocks as oposed to a single security. Closed end funds have the advantage of trading at a big discount to their net asset value in some cases’ unlike exchange traded funds that trade in real time so theirs never any discount.