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The Challenge of Measurement: ETFs vs. Mutual Funds

Unfortunately, the old-style “active versus passive” studies that consistently gave passive (index) investing, including exchange-traded funds (ETFs), two thumbs up are getting harder and harder to do. What exactly qualifies as an “indexfund anymore, now that many ETFs are set up to track indexes that, in and of themselves, were created to outperform “the market” (traditional indexes)?

And whereas index investing once promised a very solid cost savings, some of the newer ETFs, with their newfangled indexes, are charging more than some actively managed funds. Future studies are likely to become muddier and muddier.

Some advice: Give a big benefit of the doubt to index funds as the ones that will serve you the best in the long run. If you want to go with an actively managed fund, follow these guidelines:

  • Keep your costs low.

  • Don’t believe that a manager can beat the market unless that manager has done so consistently for years, and for reasons that you can understand. (That is, avoid “Madoff” risk!)

  • Pick a fund company that you trust.

  • Don’t go overboard! Mix an index fund or two in with your active fund(s).

  • All things being equal, you may want to choose an ETF over a mutual fund.

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