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Investing

Active Funds vs Index Funds: Which is Best in the Long-Run?

Investing for retirement in your RRSP and TFSA means investing for long run. Do actively manage funds deliver performance and peace of mind for Canadians?

The Evermore Team

The Evermore Team

We all deserve to feel confident about our finances. Evermore is here to make sensible investing accessible to everybody.

Using investment funds (mutual funds, exchange traded funds or ETFs, pooled funds, etc) to achieve your financial objectives is arguably the easiest way to achieve diversified exposure to various asset classes like equities (stocks) and fixed income (bonds).

Why is it easy? Well, choosing individual stocks or individual bonds is extremely challenging. Warren Buffett might make it look easy, but if you stop and think about how many Warren Buffetts are out there, you realize that he is one of those exceptions.

The financial press will frequently have portfolio managers touting their top picks, and the banks have analysts that give companies buy, sell, or hold ratings. Now a days, there are also quite a few financial “influencers” that advocate for individual stock selections, and who try and sell you courses that you give you all the “secrets”. But that’s not new, before social media, there were plenty of newsletters you could subscribe to with the next hot tip.

It takes a lot of time and energy to take all this information, separate out the noise, and make thoughtful and rational decisions for your investment portfolio on an on-going basis (when to buy, when to sell, when to rebalance, etc).

This is why investment funds started in the first place. Instead of everybody trying to figure out the market, they pooled all resources together and hired professional money managers, people who spend their entire careers studying the markets, to make the investment decisions and generate returns for investors.

The funds that have portfolio managers who pick and choose specific securities are called “active” funds. They are actively trying to generate returns that beat their benchmarks. Every active fund must have a benchmark that it is compared to. Otherwise, how do you know if the portfolio manager is effective at their job?

In the 1970s investors saw the emergence of “index” funds.   These funds didn’t try and beat the market, they were designed to deliver market returns to investors at significantly lower fees than their active counterparts. Their sales pitch was simple – long-term investors should be in the markets, but trying to beat the market isn’t easy or sustainable in the long-run, so deliver market performance as cost-effectively as possible.

But how is the average person supposed to decide between more expensive active funds that promise to beat the market, and lower fees funds designed to track the market?

First, let’s try and get a handle on the validity of the value proposition that active fund managers offer investors. Can they beat the market?

Fortunately, data has been collected over long periods of time on active fund performance by S&P Global, and you can access the results free of charge on the SPIVA Scorecard page here. SPIVA stands for S&P Indices vs Active, and tracks the performance of active fund managers across geographies, asset class, as well as investment style and categories. When you go through the site, you’ll find a glaringly obvious theme: in the long-run, in the aggregate, active management fails to beat their benchmark indices.

For a tour of the site and more details, you can also check out this video:

 

If you’ve gone through the site or watched the video, you can now appreciate what you are up against in the markets. Most professionals that do this day-in and day-out can’t beat the markets in the long-run.

If you are the type of person that has a true desire and capacity to learn about security and market analysis, has the risk appetite to trade their own account, and also has the time to devote to pursuing an active strategy (i.e. it’s the thing you love to do more than anything else with your free time), now that you are more aware of the historical data, you can at least pursue that strategy with your eyes wide open. At the end of the day, you will need to be the type of person who is content and financially secure using such a strategy, knowing that it has a high probability of underperforming an alternative that requires a miniscule fraction of all of that effort.

On the other hand, if you are somebody that would rather be doing anything else but worrying about your investment account, using investment strategies and products that are index-based is more likely to be the better route. Provided you have aligned your investment choices with your goals, an index strategy means you no longer have to worry if your fund has made the “right” stock picks, or if you’ve chosen the “right” fund manager.

What does it mean to make sure your investment choices are aligned with your goals? Check out our article on goal-based investing here.

At Evermore we focus on the retirement goal and have built index-based portfolios designed for RRSPs and TFSAs for working age Canadians. They are the Evermore Retirement ETFs. They are target-date funds that automatically make portfolio adjustments over time as you work towards retirement. To find the Evermore Retirement ETF that is right for you, click here.

 

Disclaimer

This article is for information/educational purposes only and must not be construed as specific financial or investment advice. Where relevant, consult a licensed professional financial advisor for help tailored to your specific circumstance. Commissions, trading fees, management fees and expenses all may be associated with an investment in exchange traded funds (ETFs). Please read the prospectus before investing. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated.

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