Do we need to invest in actively mange funds or index funds ?

Should one invest in actively managed funds or should one put his money in passively managed funds such as index funds? An article in Moneynews makes a case for the latter. And this by a comparison with Warren Buffett's performance. 

First of all, what are index funds? These funds are aligned to a particular benchmark index such as the S&P CNX Nifty,BSE Sensex, or even for that matter a sectoral index such as BSE Bankex. The endeavour of these funds is to mirror the performance of the designated benchmark index, by investing only in the stocks of the index with the corresponding allocation or weightage. Hence, investing in index funds is less cumbersome as compared to investing in actively managed funds. Also they carry with them a low expense ratio along with a low risk (as compared to actively managed mutual funds), making market timing irrelevant. Low portfolio churning also adds to their merit. The fund manager in an index fund exits a certain stock only when a respective stock exits from the index and is replaced by another one. 

Recently, it was highlighted how the legendary investor Warren Buffett's Berkshire Hathaway vastly outperformed the stock market during the last 49 years. In comparison, Berkshire's performance in the last 5 years has not been that exceptional. Thus, the article has stated this increased the attractiveness of index funds given that even an experienced investor like Buffett is not able to beat the market. 

Does this mean that one should stop investing in actively managed funds and only invest in index funds? We do not think so. There is no hardcore proof which suggests that index funds always consistently perform better than actively managed funds. The Warren Buffett comparison only highlights the benefits of investing in index funds. But does not conclusively prove that they are the best performing of all mutual funds out there. Besides, many investors prefer diversity which an index fund, by its very nature, does not provide. 

Ultimately, whether one chooses to invest in an index fund would depend on factors such as your investment objective, your risk taking ability, age and income profile among others. If you have enough risk taking ability and are willing to do your homework in terms of investing in good quality stocks at attractive prices, there is no reason why your portfolio should not deliver better returns than if you had put your money in index funds. 

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