Do actively-managed mutual funds’ higher costs translate to higher returns compared to passively-managed exchange traded funds (ETFs)?

When comparing mutual funds and ETFs, it’s important not to confuse cost issues with management-style concerns. Although ETFs are built like index mutual funds, they trade like stocks, and they tend to be less expensive. However, as Chuck Jaffe for MarketWatch points out, most investors aren’t able to tell the difference between an index mutual fund or an ETF tracking the same underlying index. Index mutual funds and ETFs both represent an inexpensive way to get the same return as the benchmark index. However, the point of an actively-managed mutual fund is to have someone beating the benchmark for you. Realize though, that lots of research says the average manager has a difficult time outperforming the benchmarks that his or her funds track. This means that it’s a rare case or an extraordinary manager who can deliver above-benchmark returns.

So, the decision really should be based upon what type of management style investors prefer. Are you comfortable watching your funds passively track an index, riding both the ups and the downs? Or would the benefit of having a manager active at the helm of your funds be worth the extra expense to you?

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.