**Bogle’s Investment Philosophy**
Most managers, around 85% to 90%, fail to outperform their benchmarks due to fees and transaction costs, which end up reducing the value of their investments.
**Why Choose Active Funds If Passive Ones Seem Better?**
A question I often get is why anyone would opt for actively managed funds over passive index funds, especially when passive investing appears so advantageous. Despite academic and financial blogger endorsements, the reality tells a different story. In the U.S., $9.8 trillion is in actively managed funds, while only $4.2 trillion is in passive ones, meaning 70% of U.S. investments are in active funds. As an advocate of index funds, this disparity is puzzling.
**The Origin of Index Fund Investing**
The story begins with John Bogle, who founded The Vanguard Group in 1974 and introduced the first public index fund. Initially met with skepticism, Vanguard eventually became the largest mutual fund provider, with enthusiastic followers known as BogleHeads. Bogle argued that most managers underperform their benchmarks due to fees and costs, making active management less effective.
**Cost Differences**
Active funds are generally more expensive because they incur higher costs for manager salaries, trading, and research. A Vanguard 500 Index Fund Admiral Share, with a 0.04% expense ratio, pales in comparison to some active funds charging over 1%.
**Why Do People Choose Active Funds?**
Many 401(k) plans predominantly feature actively managed funds. For instance, my own 401(k) plan offers 57 funds, of which only four are passive. With $25.3 trillion in retirement assets in the U.S., and $7 trillion in 401(k)s, the industry generates substantial revenue from fees. The prevalence of actively managed funds in 401(k) plans is a significant reason people inadvertently choose them.
**Desire for Above-Average Returns**
Many investors aim for returns higher than average, believing active management can achieve this. Historically, investing was about picking the right stocks, and this mentality persists. Some actively managed funds do outperform their benchmarks over long periods despite the general trend.
**Examples of Successful Active Management**
Vanguard’s Windsor fund, for instance, outperformed an S&P 500 index from 1976 to 2015. T. Rowe Price also found that many of their funds consistently outperformed their benchmarks in rolling periods over 20 years.
**Comparing Active and Passive Funds**
Even if active funds are criticized for high fees, not all are expensive. Vanguard, for example, offers active funds with low fees, making them comparable to index funds in terms of cost.
**Balancing Asset Allocation**
Some investors prefer actively managed funds for specific asset allocation and risk management that index funds may not provide. Vanguard’s Wellington and Wellesley funds are examples of balanced funds that maintain specific stock-bond ratios and have performed well historically with low expense ratios.
**Conclusion**
Passive index funds offer clear benefits like simplicity, low cost, and solid performance, making them excellent for any investor. However, not all actively managed funds are bad. Some offer good performance and low fees but require more research and effort to identify. Ultimately, both active and passive funds can be suitable depending on individual goals and preferences.
