Mutual funds for the most part are managed by a professional (mutual fund manager). They have costs (expense ratio, loads) associated with them because after all the manager has to be paid for doing his/her job. The goal of most mutual funds is to beat a certain benchmark. For pure equity based funds, the benchmark can be any of the equity index (S&P 500). Sadly, many managed funds do not beat the index. Index funds track the index itself and so their performance is basically capped to that of the index being tracked. Index funds require little to no management and hence are cheaper than traditional funds.
"You get what you pay for" is what we have been told all these years. You would expect a fund managed by a paid professional to be able to beat a fund that is not managed at all.
Research conducted in the
Edinburgh, Scotland, by market research firm The WM Company found that almost 75% of "active funds" deviate only marginally from their
benchmark index. The study covered data from 1980 to 2000, and found that 40% of supposedly active funds deviate by between 0-3%, and a further 34% by 3-6% per cent. The study also found that roughly three-quarters (127 out of 168) of funds simply do not beat the index.
The market indices are a good indicator of all the macroeconomic factors that affect the individual stocks. Most of these macro factors (jobs report, unemployment, inflation) have a bigger toll on the individual stock than the story surrounding the stock itself. The current recession is a classic example of how a company with good news dosen't get the same treatment it would in a bull market. Managed funds cherry pick stocks based on the stock story. They do not factor in the external, uncontrolled macro factors that affect the stock price. Index funds factor in those parameters implicitly. This is probably why money managers have a tough time barely beating the index or sometimes just meeting the index.
