The index fund officially surpasses the active managers

Alan Sloan is a seven-time Loeb Award winner, the highest honor in business journalism.

There are times when ordinary numbers tell a big story for investors – and this is one of them.

Today’s issue involves index funds: mutual funds that seek to replicate market indicators, such as the Standard & Poor’s 500 Index or the Nasdaq market, or the US stock market as a whole.

For the first time in history, retail investors’ index fund holdings have outperformed their holdings in actively managed funds, according to new figures from Morningstar Direct.

As of March 31, Morningstar said, কারী 8.53 trillion had been invested in retail investors’ index mutual funds, with ্যের 8.34 trillion worth of assets invested in actively managed funds.

I think of it as revenge on Main Street on Wall Street. A spokesman for the S&P Dow Jones index has a more elegant view: “The democratization of investment.”

In 1993, when Morningstar first began tracking index-versus-active assets, active funds had about 60 times as many assets ($ 1.25 trillion) as index funds ($ 21 billion).

As recently as 10 years ago, assets invested in index funds by retail investors were about one-third of investors in actively managed funds: $ 1.87 trillion compared to $ 5.47 trillion. But the tide has turned long ago.

By the end of last year, the wealth gap was less than one percent – from $ 8.90 trillion to $ 8.98 trillion. That’s why I recently asked Morningstar to do a special first-quarter analysis for me – and why I wasn’t surprised to see index funds emerge as a narrow lead.

Whether you call it retaliation or democratization, index assets are an amazing development rather than active assets, because active retail mutual funds have been around almost forever, while retail index funds did not exist until 1976. That’s when John Bogle, its late founder. The Vanguard Group, now known as the Vanguard 500 Index Fund, has acquired Wall Street to underwrite a small $ 11.4 million issue.

After a very slow start – “Who wants to be average?” How the fund industry attacked Bogel’s baby – index funds, especially at low cost, began to catch on. Why? Because year after year, they began to outperform most active managers in the same investment waters. And the difference comes from lower fees and costs.

Last year, according to Morningstar’s calculations, index investors saved $ 38.6 billion in fees compared to what they paid to keep their money in active funds. Because the index fund fee averages 0.43% or 43 basis points, less than the cost of the active fund. This may be a small percentage difference, but when applied to trillions of dollars, it turns into mega-boxes. Or even the giga-box.

As Vanguard’s index fund grows, Bogle’s insistence on lowering fees is one of the main reasons for the low cost across the industry. The reason for this, at least in part, is to establish Bogle Vanguard as a co-op owned by its investors, not as a conventional investment firm for investors to earn money with stockholders.

The initial annual cost of owning Bogel’s first retail index fund was 0.20 percent. Now, a retail investor can buy a Vanguard 500 Exchange Traded Index Fund that costs only 0.03 percent. And some of Vanguard’s competitors offer even lower costs on some index funds. According to Morningstar, index mutual fund fees have not only started at lower levels than their active peers, but have declined faster than active fees over the past few decades.

And now that the retail index fund is bigger than the actively managed fund, you can almost hear the bogey from the Great Beyond. Bogle, who died three years ago, had to deal with ridiculers and ridiculers for decades who called the index fund “Bogle’s folly.”

But Bogle has repeatedly (and repeatedly) spoken of what he called “The Triumph of Index Funds” and stressed that they are the wave of the future. Now that the numbers have shown us that this is the case, Bogle is getting the last laugh.

John Bogle, founder of the Vanguard Group, made the remarks during an interview with Valley Forge, Pennsylvania, on January 16, 2003, at his office on the Vanguard campus.  Bogle, an industry guru, has publicly criticized the investment fund industry.

John Bogle, founder of the Vanguard Group, made the remarks during an interview in his office on January 16, 2003, near Valley Forge, on the Vanguard campus in Pennsylvania. REUTERS / Tim Shaffer TMS

It is clear that the reason for the narrowing of the cost gap between active and passive funds is, at least in part, the pressure on active managers to improve the effectiveness of their funds compared to index funds. They have to do this because year after year and year after year, most active funds have underperformed the indicators and so the index funds have performed less.

For example, 85.1 percent of active-managed large-cap funds performed less than the S&P 500 last year, according to SPIVA data from S&P, which measures the performance gap between active-managed and index funds. In 2021, the S&P composite of about 79.6 percent of all domestic U.S. funds performed less than 1500, the S&P equivalent of the total market index.

But be aware that while ownership of low-value, broad-based index funds is generally better for retail investors than ownership of active funds or betting on individual stocks, this does not necessarily guarantee a smooth ride. Especially in the rocky times as we are now.

As of May 10, Vanguard’s S&P 500 index fund has declined 3.5 times or more 67 times since 1983, said Jeff DiMasso, research director at Advisory Investments. If you shop on those big days, he said, your average return was about 25 percent a year later. However, he says, on 10 occasions, you were down for years after the drop.

So while an S&P 500 index fund will probably work better than an equivalent actively managed fund, it does not guarantee success. But at least you will save fees.

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