By ROBIN POWELL
here are many compelling reasons to use index funds rather than actively managed funds. For a start it’s cheaper and, in the long run, that usually results in superior net returns. It’s also simpler and easier, and involves less time and aggravation. But there is another big advantage of indexing that warrants more attention than it’s given: with index funds you know exactly what you’re buying, but with active funds you don’t.
“When you buy a box of corn flakes,” writes Mark Hebner, in his book Index Funds: The 12-Step Recovery Program for Active Investors, “you expect to see corn flakes in your cereal bowl. You would not expect to see your bowl laden with granola or raisin bran with a few corn flakes mixed in. Consumers rightfully expect that packaging and labels accurately reflect the contents of their purchase. It just so happens, however, that the contents of actively managed funds often vary, sometimes significantly, from their labels or stated benchmarks.”
Style drift is usually deliberate
What Mark is referring to here is a phenomenon known as style drift. Simply put, style drift is the divergence of a fund from its stated objective. This can occur if a particular security or asset class has a dramatic move that alters its relative portfolio weight. More commonly, though, it’s the result of a deliberate decision by the fund manager to alter his or her investment style.
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This article is based on the book Index Funds: The 12-Step Program for Active Investors. The issues it raises are addressed in Step 6:
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