Even if you agree with us that index or passively managed funds are an excellent way to invest, you might wonder if the best strategy would be to hedge your bet and invest in index funds and actively managed funds. A new study suggests that mixing apples and oranges in an investment portfolio will usually produce lower returns.
Investors are more likely to generate better investment results if they stick exclusively with index funds. While the success of index investing in individual investment categories has been widely documented over the years there has been little research that compares portfolios composed exclusively of index funds with portfolios of actively managed mutual funds.
Here are some of the study’s key findings:
1. The researchers documented that the chances of an all-index portfolio beating a portfolio of active funds grew along with the investment period.
2. During a 10-year period ending in 2012, the all-index approach, which contained three funds (bonds, as well as domestic and international stocks), beat the active-fund approach employing three funds 87.7% of the time. When competing with five and ten funds in the actively managed portfolios, the success of the index portfolio increased slightly.
3. The more actively managed funds that an investor held within an investing category, such as large-cap domestic stocks or intermediate bonds, the less likely the investor would outperform an indexing strategy. As you can see from the chart below, the index portfolios beat the actively managed portfolios 82.9% of the time when there was one active fund in each category, but it jumped to 91% when three active funds were in each investment category.
4. One reason why index funds are superior to actively managed funds is that as a group they are less expensive. In the study, however, even portfolios containing cheaper actively managed funds did not meaningfully increase the chances of outperforming the index-only strategy.
This study holds important investment implications for investors. Here is the researchers’ bottom line: Investors will increase their probability of meeting their investment goals with a diversified, all-index portfolio held for the long term. An all-index portfolio is difficult to beat in the short term and it becomes even more difficult to outperform over time.