A Teenager’s Walk Through the Stock Fund Wilderness

Two  roads diverged in a wood,

and I took the one less traveled by

And that has made all the difference

–Robert Frost

The Road Not Taken, 1915

I have volunteered to teach a module on stock fund investing for students taking a new elective course at a small private high school in Sacramento. Here is a fleshed out outline of what I’m thinking about presenting. I want to educate “my kids” about the factors that ushered in the advent of the index fund and ETF and how to distinguish between the virtues and vices of their investment options. In the process, I’ll shine a light on those TV commercials showing an advisor in a tweed jacket speaking patronizingly about what to do now in a voice dripping with sincerity.

Above all, I want these 18-year-olds to feel confident and not be intimidated by advisors, brokers or their apologists. In short, I hope to add a few names to the small cadre of informed young consumers of the stock market. To be sure, nothing has been finalized after an enthusiastic handshake with the head of the high school in the spring, so all this may be the ramblings of an old fool on a belated mission. By the way, if anyone can use this article as a refresher or has a kid about to take the dive, that would be a joy.

The Road Is Long, with Many a Winding Turn

Learning how to invest in the stock market is a lot like learning how to drive. Done wisely, it will get you to where you want to go—a life of financial well-being and money for college, your first home, raising your children, and then their college. Done recklessly, investing in stocks is fraught with danger. Over the last twenty years, the overall stock market has gained an average of almost 10% a year. Pretty cool, right? But a sputtering economy and extremes of human emotion can cause this gradually rising slope to be temporarily disrupted by violent downside episodes of more than 40% a year.

After bear markets, though, the inexorable march upward resumes. How can I be so arrogant and so sure? Because it always has. Stocks have tended to finish higher over 80% of the time across ten years and over 90% across twenty. They have overcome the Crash of 1929, the dot.com technology massacre at the turn of the century and the mortgage lending fiasco of 2008.

Rolling the Dice with Individual Stocks

Buying individual stocks is risky, too risky for most of us. If management executes poorly and earnings disappoint or if the public loses confidence in its product, you will feel the pain. Boeing’s stock lost 23% in a few days following its two tragic air accidents in 2019. What could that mean for you? Well, the $1,000 your parents set aside for college textbooks is now $770.

Single-stock risk is particularly perilous. Even Apple has sustained staggering blows on the way to investor nirvana, plummeting over 50% in 2008. Sure, rooting on your individual picks is challenging and fun, but serious investing needs to be more than that—certainly so when replenishing your tuition savings account or beginning to save for a down payment. Many have said that diversification js the only free lunch on Wall Street.

What’s  a Mutual Fund, Anyway?

 Let’s say your mom would love to have a second home in Tahoe, but she only has half the money needed for the down payment. She enlists two women friends to invest 25% each into a chalet. Your mom owns 50% and each of her friends owns one-fourth. The three partners will divvy up any gain or loss in the value of their mountain retreat according to their proportionate share. A mutual fund works much the same way. People pool their money to buy stocks, with each person owning the percentage of shares represented by the size of her investment.

Cost: The Achilles Heal of Professionally-Managed Funds

 The modern era of mutual fund investing that began in the 1920s solved the problem of diversification by providing instant ownership of a large number of stocks. Until the 1980s, virtually all mutual funds were actively-managed by a professional stock picker. His mission was to replace stocks deemed overvalued with those believed to be undervalued to maximize the fund holder’s profits.

This oversight freed investors from having to monitor developments in their individual stocks, opening up time for leisure pursuits or, of course, (ugh!) homework. The aura of professional supervision is particularly attractive to individuals—including many students—without the time, ability or desire to manage their own finances.

But hold it. These features of the active mutual fund must be weighed against a stark disadvantage. The prodigious costs of maintaining a mammoth research division to turn up ideas for the portfolio managers have proven a stubbornly high hurdle for them to clear

 Index Funds: The Portfolio Manager Has No Clothes

Until the mid-1970s, the commonplace assumption was that portfolio managers’ trading skill enhances the performance of their funds. It was a slam dunk.  After all, many of them had Ivy League pedigree and most were educated in elite business schools. It was around that time that several market observers began to question the seemingly unassailable conviction that the quality of professional management determines the success of a mutual fund.

These renegades constructed an index fund consisting of all the stocks in the S&P 500. No portfolio management or trading was done, so that the fund’s holdings were fixed. As you might imagine, these skeptics were ridiculed as naïve and traitorous by brokers and advisors whose livelihoods were on the line.

But the early results with the index (or passive) fund were encouraging and stimulated considerable academic research. Over the last twenty-five years, literally hundreds of studies have confirmed that gains from actively-managed mutual funds generally do not exceed those for similar index funds. In fact, the results for index funds often eclipse those with portfolio managers. In 2024, active funds surpassed the S&P Index fund less than 25% of the time.

Just how cheap are index funds, anyway? They usually cost about one-third as much as active funds and fees for many of the largest passive funds are so low as to be incidental. Let’s bring that notion closer to home. Say your parents have socked away $50,000 toward your first two years of college tuition and associated expenses and put half into a savings account. They allocate the remaining $25,000 to Vanguard’s S&P 500 Index fund. What is their total annual cost?  $1,000? Nope. $500? Uh-uh. Try $10 (not a typo), folks, and that includes all operational and administrative expenses in addition to the management fee itself.

Passive funds are no longer the poor kid on the block. In response to investor demand, thousands of index funds have been launched, ranging from highly diversified broad market indexes like the S&P 500 to specialized offerings in areas like aerospace and real estate. With a boost from the financial media and grudging acceptance by the formerly disdainful professional establishment, a cadre of informed mutual fund consumers has been born. I want you to be one of them.

The ETF Is Not The New Model Jaguar

 By the turn of the century, the actively-managed mutual fund was fast becoming a  dinosaur. Its egregious management fees were exposed by the more efficient index fund and savvy consumers were transferring their assets from one to the other. Asset management companies, which had gorged on their expensive actively-managed funds for seventy-five years, were hemorrhaging money and shedding investors. At the same time, developers of the index fund were emboldened by its stunning success. These two unlikely bedfellows were scrambling for a new consumer-friendly product. They found it in the exchange-traded fund (ETF),

The ETF structure has several advantages over active management and even the index fund, which is actually a subclass of the mutual fund.  Though much cheaper, index funds carry other baggage of their active counterparts. Passive funds cannot be bought or sold during the market day, but only at the closing price. They are also subject to the annoying restrictions often placed on mutual and index fund investors, though limitations on the number of times you can return to a fund you recently exited would typically not apply to long-term holders of index funds.

By contrast, the ETF wrapper goes way beyond the features of actively-managed mutual funds. Since the ETF is just a new way to package passive funds, they are likewise cheap. No buying or selling occurs in either index funds or ETFs, which also share favorable tax treatment not accorded their active brethren. ETFs are also more flexible than mutual funds and passive funds, allowing trading whenever the market is open, just like a stock.

Does all this good come with any bad?  Well, the flexibility of the ETF has come under scrutiny for its susceptibility to the kind of frenzied trading that gives rise to the speculative juices. Ironically, rampant short-term trading may well be deterred by the rigidity of mutual funds’ transaction rules. And to be sure, ETF trades take place in an auction-like market with a spread between the bid and ask prices, whereas mutual and index funds are bought and sold at the closing net asset value. The friction of the ETF is a cost that makes them less amenable to accumulating or withdrawing shares repeatedly in a college savings or retirement plan.

Despite these reservations, the ETF is one of the most successful financial products ever created. Although not yet a topic of conversation at the local club, the ETF has become the darling of the investment community. By the end of 2024, assets in ETFs represented fully one-third of those in all stock funds.

As of mid-2025,  there were about four-thousand  ETFs in the U.S. and ten thousand internationally. Similar but in many ways superior to index funds, they facilitate investment in widely followed market benchmarks like the Dow and S&P, as well as tap into thematic trends like biotechnology and real estate. ETFs exist for expressing values through investing, like religious beliefs and sustainable farming. Learning how to invest through funds reflecting personal interests is a great way for you to get started. Remember, diversification and time are on your side, so save, invest and be patient.

Active Management Descends on the ETF

 You’d better look now because they’re coming. The established asset gatherers were hit by a double-whammy. First, their lucrative actively-managed mutual fund model was overrun by the proliferation of index funds of all stripes. And then the entire mutual fund design—including the subclass of index funds—was supplanted by the entirely new ETF structure. But don’t sell the enterprising fund providers short. As investors fled their costly and outmoded mutual funds for streamlined ETFs, the big boys needed a new gig. Ever inventive, they fashioned a new version of the ETF with, of course, active management.

All those portfolio managers who failed to outrun passive funds were retooled to pilot ETFs artfully priced between the cost of the mutual fund and index ETF. The marketing allure of a relatively cheap ETF combined with button-down surveillance has been breathtaking. In the last two years, new active ETF offerings have far surpassed those for index ETFs. The revamped ETF has also been stealing market share from its predecessor.

The Showdown

Whether the relocated portfolio managers will be able to tease out better results than they did steering their mutual funds seems a stretch. Unfortunately, since very few active ETFs have been around for more than a few years, little academic study comparing their performance against passive ETFs has been done to deliver a verdict. Until more research is available, we won’t know if the active ETF is indeed the Holy Grail or just another fool’s paradise.