Finally, consider the strategy of the mutual fund manager. An index fund simply buys all of the stocks (or bonds) in the market to achieve the market return. An actively managed fund tries to buy the good ones and sell the bad ones in an effort to beat the market. While in the short run, this is certainly possible (in any given year, 45 percent of funds might beat a similar index fund), over the long run, it becomes increasingly difficult to choose a winning active manager, especially after expenses and taxes. Over a lengthy investing career, the likelihood of choosing an active manager who can beat an index fund falls to less than 10 percent, and there is precious little evidence that investors can choose the winners in advance.
Mutual funds are an excellent way to invest and should be the main building blocks in the portfolios of the vast majority of investors. They provide professional management, liquidity, economies of scale, and diversification.