We have been hearing about the qualities of exchange traded funds (ETFs) compared to those of mutual funds, and now an index fund study has provided evidence as to why index funds are more favorable.

The gist of the study by Mark Kritzman, president and chief executive of Windham Capital Managment of Boston, comes down to this: Because of lower fees, the ordinary, garden-variety index fund often leads to better net returns than hedge funds and actively managed mutual funds, reports Mark Hulbert for The New York Times.

There are five differences between ETFs and index funds, we should note. These differences include how they’re traded, priced, what they cost and tax efficiency.

Kritzman has found that, with the net of all expenses involved in investing in mutual funds or hedge funds, the people in the highest tax brackets benefited more by investing in index funds. The index fund’s average after-expense return was 8.5% a year; whereas, actively  managed funds were at 8%, and hedge funds were 7.7%. It is concluded that the expenses were the deadweights that dragged down returns for actively managed funds and hedge funds.

It is also shown that only a small number of funds that beat the market in a given year can go on outperforming in the following year. Kritzman insists that active manage management is not justifiable for long-term wealth growth.

But it is noted that active management is more favorable for investing in tax-sheltered accounts, but Kritzman also says that the “odds of beating the index fund are still quite poor.”

Tags: Mutual Funds, Retirement, Taxes