(Passive) Funds for the Win

Relatively few of us have the time, skills or interest to become savvy stock pickers. For many people, it makes sense to invest in the stock market largely via mutual funds or their close kin, exchange-traded funds (ETFs). An ETF is a fund that trades like a stock, with no minimum investment amount.

Funds can be actively managed or passively managed. Actively managed funds have financial professionals scouring the universe of investments suitable to the fund, evaluating and choosing securities and deciding when to buy and sell. Passively managed funds typically track a certain index, aiming to deliver roughly the same return (less fees) by holding roughly the same securities.

So, for example, an S&P 500 index fund will hold most or all of the stocks in the S&P 500 and should deliver a similar return. The managers of such index funds have less work to do, as they simply need to copy a certain index or defined group of securities.

These funds vary widely, though, in what they charge and how well they’ve performed. Here are some tips regarding selecting funds:

• Pay attention to fees — passively managed funds tend to have significantly lower fees than actively managed ones. According to the Investment Company Institute, the average expense ratio (annual fee) of stock mutual funds in 2023 was 1.11%, though some can approach 2%. (On a $10,000 investment, a 1.11% annual fee will cost you $111.) Index funds often have expense ratios below 0.2%, or even 0.1%.

If you’re thinking that index funds look good, you’re right. Here’s the kicker: They even tend to outperform their actively managed counterparts. For example, over the past 15 years, 88% of all large-company mutual funds underperformed the S&P 500 index. (The S&P 500 index is no slouch, averaging roughly 10% annual returns over many decades.)

A good index ETF to consider is the Vanguard S&P 500 ETF (VOO), with an expense ratio of just 0.03%.