How Each Type Works

An index fund is a mutual fund designed to track the performance of a market index such as the Nikkei 225 or the S&P 500. Because the fund manager does not need to select individual stocks - the fund simply holds the constituents of the index - operating costs are kept low.

For more detail, data compilations on the edge of index investing will show you why passive strategies tend to outperform active management over the long run.

An active fund is a mutual fund in which a fund manager selects stocks based on proprietary research and analysis, aiming to beat the market average. Because it requires human resources for company visits and macroeconomic analysis, operating costs are higher than those of index funds.

The Cost Difference

The most important cost in mutual fund investing is the expense ratio (management fee). Since this fee is deducted daily throughout the holding period, even a small difference compounds into a significant impact over the long term.

  • Index funds: Roughly 0.1 to 0.3% per year. The eMAXIS Slim All Country World Equity fund charges just 0.05775% per year - an extremely low cost.
  • Active funds: Roughly 1.0 to 2.0% per year. Some popular funds charge over 1.5%.

With a 1% difference in expense ratios, investing 10 million yen over 20 years produces a gap of more than 2 million yen from costs alone. Unless the active fund consistently generates returns exceeding this cost gap, investors end up worse off.

Historical Performance Comparison

According to the SPIVA report published by S&P Dow Jones Indices, only about 10 to 15% of active funds in the US large-cap category outperformed the market index over the past 15 years. In other words, 85 to 90% of active funds lost to the index.

A similar trend is observed in the Japanese market. Over the past 10 years, only about 20 to 30% of domestic equity active funds beat the TOPIX. Moreover, there is no guarantee that past winners will continue to outperform, making it extremely difficult to identify winning funds in advance.

How to Use Each Effectively

For long-term wealth building, it is rational to construct the core of your portfolio with index funds. They offer low costs, broad exposure to overall market growth, and eliminate the risk of poor stock selection.

  • Core (70 to 90% of assets): Diversify broadly with global or developed-market equity index funds.
  • Satellite (10 to 30% of assets): Use active funds with strengths in specific themes or regions to pursue additional returns.
  • Beginners - 100% index: When you are new to investing, index funds alone are sufficient. A simple strategy captures market-average returns.

Whichever you choose, always check the expense ratio and use our simulator to estimate the long-term cost impact. Comparing the 20-year outcomes of 5% annual return versus 4% (a 1% expense ratio difference) will drive home the importance of costs.

a guide to choosing low-cost funds will help you see how expense ratio differences affect long-term returns.