Why Index Funds Outperform Equity Mutual Funds

August 2, 2015

Index mutual funds biggest advantage is their low costs. After stock mutual fund costs of brokerage commissions, sales loads, bid-ask spreads, management fees, and advertising are deducted, the returns are about 2-3% lower than a broad market index fund. This might not seem like much, but over the course of a lifetime of investing the difference is huge.

Fund investors sometimes earn even less because of poor market timing and under performing funds (Buy High/ Sell Low, Dot.Com Bubble).

For example, $10,000 with a 5% average return compounded annually over a 50 years,  is worth $144,674, while the same amount and time at 8% yields $469,000. Higher costs matter. This site can be used for interest calculations- http://www.thecalculatorsite.com/finance/calculators/compoundinterestcalculator.php

All Index Funds are not created equal however. Some have sales loads or class B shares with high annual fees. Look for index funds with an expense ratio in the .05 to .10 area.  So perform your due diligence when investing in them.

I forget who said “The best way to make money with mutual funds is to invest in the company that sells them.”

S&P has been in a trading range(2040 to 2130) since February. I’ll be concerned if it drops to the 1980 area.



Welcome to The Index Investor Plus

I retired 11 years ago and received a lump sum from my employer of 28 years. I did what almost everyone else did with their money, rolled it over to an IRA  and hired a financial advisor to invest it for me. The returns were not too bad. The account averaged about 5% per year.   I was paying the advisor 1/2% yearly on the total amount in my account. The mutual funds that I was invested in had fees ranging from 1/2% to over 1%. One had a front end load of 5.75%.

After reading that most mutual funds( 96%) fail to beat their benchmarks, I decided to do some research on the reasons why:

Mutual fund fees make a big difference over time.

Average market return (S&P 500)  is 9.6% from 1990 to 2014.

Average mutual fund return is 5% per year

Add in advisor fees and the return is even less. I was paying 1/2% but 1% is the most common fee. 1% of a 5% return is a 20% reduction. I never thought of it that way!

I knew I was paying these fees, but never realized how they could add up.

It is also difficult for funds that do beat their benchmarks to continue to do so.

So what was a better way to invest? I thought why not invest in the benchmark that everyone is trying and failing to beat! I found SPY, VOO, and several mutual funds that buy all the stocks in the S&P 500 index or any broad market index  and has very low fees.  SPY’s annual fee is .09% and VOO’s annual fee is .05%. I used Yahoo Finance to find the expense ratios. Just type in the fund symbol and it’s under the profile header on the left menu. Shows up under fund operations.

An excellent site to compare fund costs is http://apps.finra.org/fundanalyzer/1/fa.aspx

http://investor.gov/ is another good site for unbiased investing information.

Personally I prefer the ETF’s to mutual funds because they can be bought and sold during the day. But it really doesn’t matter which one is used.

So low cost index funds seemed to be the best way to invest (for me anyway).

Market gurus (Warren Buffet, John Bogle,etc.) recommend buying low cost index funds and never trading them. Ever. I have to agree, to a point. Using 3 different long term market indicators that all agree to sell an index results in even better returns. The indicators have only flashed sell / buy signals 4 times in the past 15 years. For example, they showed a sell signal on the S&P in early December 2007 at 1468 and a buy in early July 2009 at 987. Avoiding a 33% drop.

That’s how I came up with the name Index Investor Plus. It’s buy and hold……… to a point!

More to follow,