Your Fund Could Prosper Without a Manager

The price of having an expert run your fund is reflected in higher expense ratios. Some actively managed funds deduct as much as 1.5% from returns as fees, compared with the 0.5% index funds typically charge.

Index funds' advantages: Which fund type will earn you bigger returns in the long run? It depends on whether index funds' lower expenses make up for actively managed funds' potentially larger returns. Kritzman's research suggests that lower expenses lead to higher long-term returns. Similar studies in previous years have yielded comparable results.

Moreover, the actively managed mutual fund and the hedge fund in the study needed to beat their index-based counterpart by far more to compensate for expenses. Specifically, the actively managed mutual fund would need to beat the index fund by 3.5%, while the hedge fund would have to outperform by a whopping 10%.

However, just because one imaginary index fund beat two actively managed funds doesn't necessarily mean the same thing would happen in the real world. A complex web of factors influences any fund's returns. Kritzman used industry averages for volatility, turnover rates, and transaction and performance fees. The study would have turned out differently had he used funds with different characteristics or if he modeled his calculations on different tax rates.

What this means for you: Do index funds' superiority mean you should dump your shares of actively managed funds? Not necessarily. First, the fees and tax implications of moving your assets around could be more than any savings that might come from lower expenses. You might also have an actively managed fund that would be hard to replace with an index fund.