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Index Fund Investors Earn More From Investments

by Flexo on December 28, 2007. Filed under Investing.

Trying to beat the market through trading based on impressions of short-term trends has the opposite effect.

There’s a new study assembled by researchers from three university that shows that those who invest in index funds have better investment returns than those who invest in managed funds. In fact, those who invest in no-load index funds have better returns than those who invest in load index funds (which have additional fees).

The investment results are compared with their own funds. Index fund investors beat the stated returns of their funds.

Investors in no-load (that is, no-commission) index funds actually beat the returns of the funds they hold by 0.42 percentage point annually… Those active-fund investors lag the returns of their funds by an average 1.86 percentage points annually.

To explain further, the 5 year average annual return of VFINX, the Vanguard 500 Index matching the S&P 500 Large-Cap Index, is 11.48%. The average index fund investor, according to this research, actually earns 11.90%. The average investor in AIVSX, a large-cap managed fund with a 5 year average annual return of 12.08% with a 5.75% front-end load, actually earns 10.22% annually.

This is attributed to trading behaviors. Index fund investors are less likely to enter and leave the stock market at the wrong time.

The study was sponsored by Zero Alpha Group, an organization that holds the philosophy that the best investment strategy is passive investing. “Zero alpha” refers to the idea that active management of a fund provides no benefit over a benchmark like an index.

Index-Fund Tortoises Are Long-Term Winners [Wall Street Journal]
Press Release from Zero Alpha Group
Investor Timing and Fund Distribution Channels [pdf Report]

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Flexo, the owner and creator of Consumerism Commentary, has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow him on Twitter.

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Online Savings Blog
December 28, 2007 at 2:58 pm

{ 4 comments… read them below or add one }

1 The Saving Freak December 28, 2007 at 9:52 am

So you can trust your money to an “expert” or you can just invest in capitalism. I think I will take capitalism.

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2 Mrs. Micah December 28, 2007 at 1:25 pm

I *heart* VFINX.

I don’t understand why more people don’t buy it or something similar. Or even simple target retirement funds. I’ve met a fair number of people who are reluctant to sell their employer’s in their 401(k)s and thus have strangely-weighted portfolios. Or who buy a few big stocks they think will do well. *sigh*

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3 Sun December 29, 2007 at 1:08 am

That AIVSX example is quite misleading IMO. There are plenty of funds out there returned quite well but don’t carry a load. I can give you an example of CGMFX, an actively managed fund whose 5-year annualized return is 37.16% according to Morningstar. Though the fund has a 1.02% ER, I won’t replace it with an index fund.

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4 fessormojo January 4, 2008 at 5:27 pm

I would humbly suggest that the fair comparison is not the five-year track record but the 21st Century track record of returns since 12/31/1999 which would include the full cycle including the three years of 2000-2002 when S&P 500 index funds (I assume that is what you are talking about) which wiped out a lot of retirement savings.

If you had to withdraw during that period you could have wiped out much of your savings in a short time. If you “stayed the course” you might have enjoyed buying at the bottom but not the route there.

Index funds like “actively-managed funds” did nothing to go to cash or sell securities short to protect investors money over a three-year period. That’s what they promissed to do and what they did.

Markets are too volatile not to diversify among the strongest sectors or to invest only domestically and overlook foreign stocks enjoying real growth as China drives the world economy. Think about it.

I don’t want to pick a fight, simply suggest that there is nothing wrong with a prudent proactive management program unless you are lazy or refuse to entertain the possibility and acknowledge that some have made it work.

After all this is investment management, not investment storage.

Bill Donoghue

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