Invest for (almost) free!
From Mark Perry at Carpe Diem:
"With expense ratios of only 0.07%, the Vanguard Total Stock Market ETF (VTI) and the Vanguard Large Cap ETF (VV) hold the record for the lowest expense ratio among the 835 Exchange Traded Funds (ETFs) listed here. That would be only $70 in expenses for an investment of $100,000. Like the street merchants selling souvenirs on Arbat Street in Moscow declare "'Our prices are so low, it's almost free.'"
Compare that to the average expense ratio for domestic stock funds of 1.37%, according to Morningstar. If beta (the market return) can be had for 0.07%, you're paying 1.30% for alpha (the degree to which a manager beats or loses to the market).
But by now, you know that most investors are paying 1.30% to lose to the market. According to Standard & Poor's, as of mid-2009 62.95% of large-cap funds lost to the S&P 500, 73.48% of mid-cap funds lost to the S&P 400, and 67.68% of small-cap funds lost to the S&P 600 over the past five years.
When you look at average annual returns, the average large-cap fund actually edged out the S&P 500, -2.21 to -2.25%, but actively managed mid-cap funds underperformed by 1.23% a year, and small-cap funds underperformed by 1.12%.
This all makes "alpha" really, really expensive.
I'm not dogmatic about index funds; I own several actively managed funds, as well as some individual stocks. But my portfolio is built on a foundation of index funds, and I branch out from there, fully aware of the odds I'm playing.
P.S. Standard & Poor's isn't necessarily a disinterested bystander in the "active vs. passive" debate, since they get licensing fees for every fund that tracks one of their indexes. So I would be interested to see other studies, or criticisms of S&P's methodology.
Robert Brokamp is the senior advisor for The Motley Fool’s Rule Your Retirement service.