More than seven in 10 U.S. investors consider low-cost index funds the best way to build long-term wealth, according to a Gallup poll from September 2021.
For two decades, the biggest players in the asset management industry have been preaching a simple message to traditional investors: Forget the high costs of traditional mutual funds, whose managers seek superior returns through bespoke trading strategies. Instead, opt for cheaper, better-performing index funds run by a computer program that replicates the highs and lows of a benchmark index, like the Standard & Poor’s 500 index of blue-chip US companies. The Pitch: Sitting to “passively” mirror the highs and lows of an established formula earns you more money in the long run.
But the passive principle is not as clear cut as millions of investors and advisers think. Index funds are both mutual funds and tax-advantaged exchange-traded funds (ETFs are like a mutual fund but trade like stocks). And their yields can vary widely.
The new “closet activist” index funds pick winners and losers and hide their daily holdings, much like a mutual fund. Conversely, some high-cost mutual funds are disguised indexers. Even the performance of vanilla funds that track the same benchmark varies. Last October, the The SEC warned investors on summary practices relating to the fees, investment strategies and performance of certain index, pooled and exchange-traded funds.