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Q: I can get an S&P 500 index fund with an annual expense ratio of just 0.03%, but most of the actively managed mutual funds I’ve seen have expense ratios of 0.50% or more. Do these fees typically translate into higher returns?
It might seem to make sense that the higher fees associated with actively managed mutual funds would generally correspond with better investment performance. After all, shouldn’t a basket of stocks selected by highly paid professionals be able to outperform a passive stock index?
However, that’s generally not the case. In 2016, for example, just one-third of actively managed large-cap mutual funds beat the S&P 500‘s performance, according to S&P Dow Jones Indices. For small-cap and mid-cap mutual funds, the record was even worse, with less than 15% and 11% of managers, respectively, beating the market.
And over long periods of time, the results are extremely discouraging. Fewer than 8% of large-cap fund managers were able to beat the market over the past 15 years, which is generally considered to be a complete market cycle.
To be fair, I’m not saying that no actively managed mutual funds are worth the cost. For example, two of my favorite mutual funds, the Dodge & Cox Stock Fund and the T. Rowe Price Blue Chip Growth Fund, are actively managed. However, I could only justify paying the relatively high cost if a fund’s record clearly showed a history of market-beating performance.