The list of stocks that comprise an index and their weights in the index are determined at infrequent intervals (sometimes as infrequently as once per year) by the index sponsor and then are distributed to the public. As a result, an index fund does not need a manager to pick stocks. All that is necessary is the intervention of a trader to make sure that the fund or ETF portfolio contains the right stocks in the right proportions. Although this is not a trivial undertaking, it is nowhere near as expensive as maintaining a research staff to pick stocks.
In theory, the average investor can do only as well as the market. It turns out that most mutual funds managers do not fare very differently from the universe of stocks from which they select. As a result, the index fund has an immediate advantage. Its performance before fees is by definition average, but it saves the considerable cost of a manager, giving its performance net of expenses a head start compared to the average mutual fund.
The only way that the average fund can overcome the handicap of higher expenses (compared to ETFs and other low-cost index funds) is for other market participants to have consistently below-average performance.
This might once have been the case when many individual retail investors picked their own stocks. Now, however, institutional investors dominate the stock market, so a source of consistently underperforming investors to help mutual funds deliver above-average performance is unlikely to emerge. As a rule, therefore, a mutual fund that has a well-defined index benchmark should be more likely to lag than to beat the benchmark, particularly over the long term. The evidence in the next section shows that in most stock market categories, indexing has beaten the majority of actively managed funds.
Read More : Investments That Track Market Indexes Have Outperformed Most Mutual Funds
