U.S. stock investors reached a milestone last year. For the first time, money invested in stock index funds and exchange-traded funds (ETFs) exceeded the amount in actively managed U.S. stock funds, according to Morningstar Direct.
That's a sign that individual investors are getting smarter. Index mutual funds and ETFs are "passive," aiming to track a benchmark, such as the S&P 500 index.
Passive funds cost less to own, and that is a big reason why they typically deliver better returns than actively managed funds. While the manager of a mutual fund may be able to outperform a rival index fund or ETF for a year or two (or more), the data is clear that it's exceedingly hard for active funds to consistently do better than passive funds over long stretches, as the weight of charging higher fees brings down their net performance.
According to Morningstar, in the 10 years through the middle of 2019, fewer than one in four active funds did better than index funds or ETFs.
For instance, the large-cap blend category includes the most popular funds that track the S&P 500 or "total market" indexes. In the past 10 years, fewer than one in 10 active large-cap blend funds outperformed their passive counterparts.
Morningstar reports that at year-end, 51.2% of equity fund money was riding on passive, close to 49% sticking with active management. (Looking at all asset classes, including foreign stocks and bonds, the migration to passive is not as pronounced. As of mid 2019 about 44% of all fund and ETF assets -- not just U.S. stock funds -- were passive.)
If you've still got a chunk of money riding on active, it's worth asking yourself why.
You get more for what you don't pay for
The vast majority of index mutual funds and ETFs charge an annual fee, called the expense ratio. (Fidelity recently launched four zero-index funds that waive the fee entirely.)
The expense ratio is embedded in the fund's accounting; you won't see it as a separate line item in your statement. But it's super easy to find. Log into your account, or just do a web search of a given fund or ETF. The expense ratio will be displayed on the first page. It is reported as the percentage of the fund's assets that are deducted to cover fund costs.