Investing Deathmatch: Managed Funds vs. Index Funds

Two methods of investing in the stock market enter the ring.

Only one will leave victorious.

Welcome to… INVESTING DEATHMATCH!!!!!!!!!

Hey! Get back here! Don’t you dare click away. This is fucking important and I am stretching a goddamn WWF metaphor past the bounds of decency to make it interesting for you.

So sit your ass down and learn a thing.

Before we ring the bell and start this fight, we should get the basic concept of investing out of the way. Investing in the stock market means you buy tiny chunks of various companies and in return you get tiny chunks of their profits. These tiny chunks add up over time so that you make more money than you would if you just put your money in a savings account.

Got it? For more on investing, check out this beginner’s guide over at Half Banked.

Ok. Now I want a good, clean fight…

The reigning champion: managed funds

For most of the history of the stock market, people have primarily relied on actively managed funds to handle their investments. A managed fund is an investment program that is managed by an investing professional. You give them your money, and they hand pick which stocks to buy with it in an attempt to get you the greatest return on your investment. In exchange, they get a cut of what your investments earn.

Sounds like a good deal, right? Instead of having to educate yourself on stocks and bonds and a whole host of other terrifying investment terms, you just hire someone who knows all that stuff already. Someone with the confidence to do this on national television:

Instead of having to educate yourself on stocks and bonds and a whole host of other terrifying investment terms, you just hire someone who knows all that stuff already.

They invest your money on your behalf, making calculated risks and spending time tracking various stocks and companies and stuff. And because they’ve spent their whole career working in the stock market, you can proceed with the assumption that without their help, you’d be up a creek without a paddle. They can make your money work harder than you can.

A small percentage of your investments seems like a small price to pay for that kind of specialized knowledge, right?

… right?

The upstart challenger: index funds

By contrast, index funds—also called ETFs or Exchange Traded Funds—are a relatively new invention. They were first pioneered by Jack Bogle (who went on to found Vanguard) in 1976.

With an index fund, you’re using your money to buy a slice of the entire stock market. So instead of paying a professional to carefully hand pick individual stocks and bonds, you’re just buying a little bit of everything. Then you set it and forget it. No educated, highly paid professional investment manager necessary. Just a cocky newcomer with a surefire strategy.

As a result, the costs of having an index fund are significantly lower than the costs of having a managed fund, since you’re not paying for management.

The costs of having an index fund are significantly lower than the costs of having a managed fund, since you’re not paying for management.

No one is scrambling to buy and sell your stocks to try and get you a higher rate of return. And no one is risking losing that gamble if the stocks they pick fail to deliver.

Instead, you’re playing the long game: just sit back, relax, and wait for the market to continue its historically upward trajectory, fattening your investment portfolio along with it.

The broad exposure you get (meaning you own stocks in companies that are going to do well and companies that are going to tank and everything in between) decreases your overall risk of losing money. And while you won’t experience the temporary high of watching your managed fund skyrocket when your manager wins a gamble, you also won’t suffer the agony of watching your funds get swallowed by the Sarlacc.

While you won’t experience the temporary high of watching your managed fund skyrocket when your manager wins a gamble, you also won’t suffer the heartbreak of watching one of your stocks get swallowed by the Sarlacc.

And the winner is…

I’ve been withholding one very important piece of information from you:

Managed funds suck.

They’re not even in the same weight class as index funds. This fight is less like pro wrestling and more like an awkward slow dance.

The odds of managed funds winning this match are a mathematical improbability.

No really! The whole reason Jack Bogle even came up with the idea of index funds is because managed funds almost never beat the market. A drunken bonobo flinging poo at a giant spreadsheet of the stock market has as much chance of picking the right stocks to beat the market as your highly paid fund manager.

A drunken bonobo flinging feces at a giant spreadsheet of the stock market has as much chance of beating the market as your highly paid fund manager.

Factually speaking, the likelihood of an actively managed fund beating an index fund is about 1 in 20. This fight was rigged from the very start.

Index funds are safer, easier, cheaper, and provide you with a higher guaranteed rate of return than managed funds. Full stop. So ladies and gentlemen, I think we have our winner.

Remember Jack Bogle, inventor of the index fund? Even Warren Buffett, the Wizard of Omaha himself, once said of Bogle, “If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle.” So yeah, index funds are pretty fucking baller.

But how can this be? How can the conscious, informed efforts of a highly trained professional lose to what basically amounts to an automated process? How is an educated fund manager on a level with that drunken, poo-slinging bonobo?

The market fluctuates up and down from day to day. Various stocks will rise or plummet over the passage of time. But, historically speaking, the stock market as a whole is on a gradual upward trend into the future. And therefore, so is your index fund. No guesswork or calculated risks can beat this fact.

This isn’t just a theory. Peer reviewed studies have shown that the costs of paying for active management far outweigh the returns simply because of the role luck plays in stock picking. You could gamble on getting lucky once or twice… or you could just sit back and let the stock market do its thing.

I would not fucking bet on that fight.

So you can pay a person a big chunk of money to fiddle around trying and failing to make your investments earn more money.

Or you can pay a small chunk of money to set it, forget it, and do just fucking fine over the long term.

Ignore the desperate snake oil salesmen of managed funds. Put your money in a damn index fund where it’ll do the most good with the least cost and effort.

KNOCKOUT

I feel compelled to remind you that as of this moment, Bitches Get Riches does not accept advertising, affiliate links, or sponsorships of any kind. Neither Jack Bogle, Vanguard, nor any other index fund provider is paying me to write this.

I’m writing it because it’s true.

And if you need further backup, listen to Stephen Dubner’s excellent episode of the Freakonomics podcast on the topic. For while Freakonomics does accept advertising money, they are… ever-so-slightly more famous and powerful than your humble Bitches. As a result, they are able to get the truth straight from the horse’s mouth, through interviews with learned economists.

The stock market is a benevolent yet confusing alien beast crawling with noisy parasites intent on separating you from your money. (Apologies for comparing stock brokers to parasites. I did not mean to insult the parasitic organism community.) It can be extremely frightening and disorienting, especially if you haven’t done your research.

So before you dive into the stock market head first, I wanted to get this out of the way. Index funds are better for you than managed funds. Anyone who tells you differently is trying to sell you a managed fund.

And yes, I have been watching and loving GLOW.

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20 thoughts on “Investing Deathmatch: Managed Funds vs. Index Funds

  1. VTSMX, baby! At least until I break 10k in my taxable and can switch over to VTSAX!

    I’m just thankful I learned that before I started actually investing, and that I only had one previous 401(k) to switch over to index funds instead of whatever the hell I had in it.

      1. The money in that 401(k) was invested in various other things that that company offered, I don’t remember what. When I left that company I left it alone for a bit, and once I’d read enough about investing, I rolled that 401(k) over to Vanguard, where that money’s now invested in index funds. My 401(k) with my current company is also invested in the index funds that they offer.

  2. Bs, how the hell do you leave a managed fund though?! I wanna but I keep getting spooked!
    Every time I’m about ready to move, the market dips and I’m hesitant to sell everything that low in order to open the new account I want…and with the cheaper ETF/index funds, I can’t find a person to call and walk me through it without becoming a customer first!

    1. This is a GREAT question. And honestly… I’m not sure! I would say you should just pull the plug, but you make a great point about the value dipping right when you make the switch. So I open it up to Bitch Nation: anyone have some advice for MH?

    2. Vanguard at the very least offers a Transfer of Assets account – meaning that you open an new account with Vanguard under the same registration as your old account (ie. individual non qualified, IRA, Roth, etc) with a form called a Transfer of Assets which will speed along the, well, transfer of your assets so that when you sell from your previous fund you’re immediately buying into the new one. If the market dips, it should have dipped for both funds. That’s the best I can offer you I think.

      1. Thanks, this is remarkably helpful, it’s stressful not knowing the right words to google! The dip-answer is very reassuring.
        And you guessed it, I’m heading to Vanguard. 😉

      2. Seconding the going through the roll-over/transfer process with Vanguard. Let them handle all the actual transferring (and don’t be like me, where I cashed out my 401(k) and then opened a Vanguard account for that money right after instead of transferring it over automatically)!

    3. Do it gradually. If you have 10k invested, pull out 1k every month and switch it over. That way some portions will be lower and some higher, and will even out in the end.

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