Using broad-market index funds instead of actively managed funds as a long-term core holding (the portion of money you keep invested for years)

17. Using broad-market index funds instead of actively managed funds as a long-term core holding (the portion of money you keep invested for years)

Cost: There is no direct monetary cost. The trade-off is that you give up the chance of picking a “star fund manager.” The harder part is that when the index drops, you must endure those losses too — you can’t simply sell out midway.

In plain terms: The collection of stocks held by actively managed funds already closely mirrors the overall market. Yet the extra management fees they charge are deducted straight from your actual returns. When we repeatedly re-randomize fund performance data to test how much luck plays a role, very few funds manage to generate enough outperformance to offset those fees.

Benefit: Collectively, U.S. actively managed equity funds hold a portfolio very similar to the broader market. However, their high management costs directly translate into lower net returns for investors after fees are deducted. This research used a bootstrap simulation method to repeatedly shuffle fund performance data and gauge how much could be attributed to luck alone. The results show that only a tiny fraction of funds achieve excess returns large enough to cover their fees (U.S., published 2010). S&P Dow Jones Indices conducts an annual review: in 2024, 65% of U.S. actively managed large-cap equity funds underperformed the S&P 500. Over a 24-year span, an average of 64% underperformed each year. In the 15 years ending 2024, no single fund category saw a majority of active funds outperforming their respective benchmarks.

Evidence grade: B

Sources: Fama EF, French KR (2010). Luck versus Skill in the Cross-Section of Mutual Fund Returns. The Journal of Finance 65(5):1915-1947. <https://doi.org/10.1111/j.1540-6261.2010.01598.x>; S&P Dow Jones Indices (2025). SPIVA U.S. Scorecard Year-End 2024. <https://www.spglobal.com/spdji/en/spiva/article/spiva-us/> (The official website refuses to be automatically captured, and the numbers are checked against the archive of 2025-05-12: <https://web.archive.org/web/20250512071051/https://www.spglobal.com/spdji/en/spiva/article/spiva-us/>); S&P Dow Jones Indices (2025). SPIVA Asia Ex-Japan Scorecard Mid-Year 2025 (Report 1a, China Large-Cap underperforms the S&P China A 300: 60.5% in 1 year, 69.6% in 3 years, 50.8% in 5 years). <https://web.archive.org/web/20251103165922/https://www.spglobal.com/spdji/en/documents/spiva/spiva-asia-ex-japan-mid-year-2025.pdf> (Official website rejects automatic crawling, check according to archive); Harvey CR, Liu Y (2022). Luck versus Skill in the Cross Section of Mutual Fund Returns: Reexamining the Evidence. The Journal of Finance, 77(3). <https://doi.org/10.1111/jofi.13123> (Disputing Party)

Notes: Debate exists: one study re-examined this conclusion and argued that the original Fama-French methodology of repeatedly re-sampling data might be overly strict. Under that approach, even funds with genuinely strong outperformance could be classified as “no different from luck.” Thus, the claim that “almost no active funds possess skill” might be overstated. In China, the data is less one-sided than in the U.S. As of June 2025, S&P Dow Jones statistics show that for A-share large-cap active funds, 60.5% underperformed the S&P China A 300 Index over one year, 69.6% over three years, and 50.8% over five years. This dataset only covers up to five years, so longer-term figures remain unavailable. Consequently, while it is still uncertain whether active funds consistently underperform in China, the advantage of lower fees for index funds remains valid. This information does not constitute investment advice.