Why has indexing become so popular?
The rise of investing strategies that track the markets, rather than look to outperform them, has dramatically transformed the capital markets and the changed the way many individual investors think about their portfolios.
Today, the largest (in terms of assets) mutual fund, Vanguard Total Stock Market Index, and exchange traded fund, SPDR S&P 500, track the returns of well-known U.S. stock indexes.
According to the Wall Street Journal, funds that track broad U.S. stock market indexes now have more money invested in them than their stock-picking actively-managed rivals. This change in investors’ preference has dramatically transformed the financial markets. In the last ten years, nearly $1.4 trillion of net cash flows were added to U.S. funds (both mutual funds and ETFs) that track market indexes, while about $1.3 trillion was withdrawn from actively managed funds. (1)
It’s not hard to understand why indexing has become so popular. During the 2008 financial crisis, investors realized that active funds didn’t protect them from the downturn. And during the lengthy bull market that followed, active managers’ performance didn’t keep pace with index funds.
Looking back at the 15 years ending December 2018, only 18% of active stock mutual fund managers beat their benchmarks. For bonds, the failure rate was even worse, with only 15% winning. (2)
You better be awfully confident in your choice of active fund managers if more than 4 out of 5 fail at their mission.
In US dollars. The sample includes funds at the beginning of the 15-year periods ending December 31, 2018. Winners are funds that survived and outperformed their respective Morningstar category benchmark over the period. US-domiciled open-end mutual fund data is from Morningstar and Center for Research in Security Prices (CRSP) from the University of Chicago. Past performance is no guarantee of future results
(1) WSJ 9/18/19 “Index Funds Are the New Kings of Wall Street”, based on Morningstar research as of 8/31/19
(2) DFA Mutual Fund Landscape 2019, US domiciled open end mutual fund data from Morningstar