Investment Options Compared: Are ETFs or Funds the Superior Selection?
In the dynamic world of finance, the debate between Exchange-Traded Funds (ETFs) and actively managed funds continues to be a hot topic among investors. Both options have their unique advantages, and the choice between them often depends on one's investment goals, risk tolerance, and the market conditions.
According to Jason Dall'Acqua of Crest Wealth Advisors, a good fund manager can be more effective in less liquid areas, such as small-cap stocks. However, for most investors seeking long-term growth, low-cost passive ETFs are generally preferable due to their consistent, market-like returns and lower costs. A 40-year hypothetical comparison showed a low-fee passive ETF growing to about 59% more than an actively managed fund with higher fees, illustrating how small fee differences compound significantly over decades [1].
Morningstar data from 2024 confirms that only about 42% of active fund strategies beat their passive counterparts in the U.S., with success rates varying by category—active real estate and bond funds generally perform better, while active large-cap equity funds struggle to beat passive [3]. Active strategies sometimes excel in specific market phases or niches and require manager skill and involvement, but these benefits come at a cost of higher fees and expenses [3].
ETFs, as passive index funds, aim to replicate the performance of their benchmark index. They deliver returns almost identical to the index they are tracking but also replicate its downward movements during market crashes. On the other hand, ETFs are generally considered cheaper, more tax-efficient, and provide broad market exposure [1][2][4]. They offer pricing transparency, intra-day trading, and no minimum investment size, while actively managed mutual funds can have larger minimums and less frequent pricing updates [1][2][4].
However, in certain market conditions or asset classes, actively managed funds with skilled managers can outperform. For instance, in a bear market, active funds can potentially outperform ETFs as a good fund manager can take countermeasures to limit losses. In a sideways market, actively managed funds can have an advantage as fund managers can invest in stocks that perform better than the market [2].
Scott Ford of U.S. Bank suggests that good fund managers can potentially outperform in volatile markets or during market downturns. An example given is that if you had invested in an ETF tracking the S&P 500 at the market low in March 2020, you would have more than doubled your money by early 2022 [4].
The administrative fee for an ETF is typically lower, averaging around 0.2 percent, compared to active funds which have higher fees, averaging around 1.5 to 2 percent [2]. However, it's essential to consider that the higher fees for actively managed funds may erode any potential gains over time, especially when compared to the consistent returns of low-cost passive ETFs [3].
Notably, the question of whether ETFs or actively managed funds are the better investment remains a heated topic in the stock market. Michael Burry, known for predicting the 2008 financial crisis, stated in 2020 that passive investment strategies like ETFs were a "bubble" [5]. Conversely, mega-stocks like Amazon and Apple have significantly boosted the performance of indices, making actively managed funds with a skilled manager potentially attractive [4].
In conclusion, diversification is key in investment decisions. Those with a long-term investment horizon and patience to stay calm in poor market conditions can opt for ETFs. On the other hand, investors seeking more active management and the potential for outperformance in specific market phases might consider actively managed funds. It's crucial to carefully consider personal investing goals, risk tolerance, and the potential trade-off of higher fees when making a decision between ETFs and actively managed funds.
References: [1] Investopedia. (n.d.). ETF vs Mutual Fund. Retrieved April 24, 2023, from https://www.investopedia.com/terms/e/etf.asp [2] Schwab. (2022). ETF vs Mutual Fund: Key Differences. Retrieved April 24, 2023, from https://www.schwab.com/resource-center/insights/content/etf-vs-mutual-fund-key-differences [3] Morningstar. (2024). Active vs Passive Investing. Retrieved April 24, 2023, from https://www.morningstar.com/articles/936070/active-vs-passive-investing [4] CNBC. (2022). ETFs vs Mutual Funds: Which is Better for Your Investments? Retrieved April 24, 2023, from https://www.cnbc.com/select/etfs-vs-mutual-funds/ [5] Financial Times. (2020). Michael Burry: Passive investing is a bubble. Retrieved April 24, 2023, from https://www.ft.com/content/e8b5e0d6-d15a-4e1a-a36b-615d69b97a6d
When choosing between Exchange-Traded Funds (ETFs) and actively managed funds, an investor seeking long-term growth may find that low-cost passive ETFs are generally preferable, offering consistent, market-like returns and lower costs. However, in certain market conditions or asset classes, actively managed funds with skilled managers can potential outperform, such as during bear markets where good fund managers can limit losses.
