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For years investors have been passing over actively managed mutual funds in favor of cheaper index-tracking options. Now active funds are themselves getting cheaper, and some market pros think it's time for investors to give them a second look.

Over the past decade, index funds – which aim to match rather than beat stock market returns – have been gaining fans, collecting tens of billions in new investment dollars. One big reason for their popularity is their low fees, which have grown steadily cheaper as a price war rages between investment firms. In fact, investment giant Fidelity even offers zero-cost index funds now, with competitors like Charles Schwab soon to follow.

Costs matter for investment returns. Every percentage point in annual fees that investors pay to asset managers gets subtracted from investors' annual returns. In other words, if the stock market rose 10% in a given year, an actively managed fund with a 1% expense ratio – once a common industry standard – would need to return 11% just to match the return of an index fund. (In actuality, index funds' returns are also reduced by their own expense ratios, although these are typically much smaller.) Historically, only a small handful of actively managed funds clear this hurdle, outperforming the market by more than the amount of their fees.

Here's what you might not know: While it's no secret that index funds are less expensive, active fund mangers have been responding by lowering their prices. In fact, the average asset-weighted expense ratio for actively managed U.S. large-cap stock funds has decreased by almost a third, from 0.92% in 2004 to 0.65% today, according to Morningstar. And as fees continue to fall, active funds should, in theory, see their performance improve.

"If you reduce cost, there's a greater mathematical probability of beating the benchmark," says Tim Paulin, Senior Vice President at Touchstone Investments.

To be sure, even with today's lower costs, most active funds still lag the market. Last year, only about a third of actively managed U.S. stock funds tracked by Morningstar outperformed similar index funds (although active managers tend to be more successful in the bond market, with about 70% of intermediate-term bond managers outperforming last year.)

That said, inexpensive active funds gave investors a much better shot of beating the market than pricier options. Over the past five years, the cheapest stock funds – those with expense ratios in the lowest quartile in Morningstar's database – returned roughly 9.4% a year. Those with expense ratios in the highest quartile returned only 4.4%.

So if you do want to try to beat the market, it's not hard to find some cheap funds with a good track record that meet this criteria. Here are some recommendations.


Vanguard Wellington Fund (VWELX)

Founded in 1929, Vanguard Wellington is Vanguard's oldest fund. Portfolio managers Edward P. Bousa and John C. Keogh, whom Morningstar describes as "seasoned," have both been in place for more than a decade. That's helped the fund, which is also on our Money 50 list of recommended mutual funds, return nearly 11.9% a year, on average, over the past decade – handily beating the 9.9% return of the benchmark assigned by Morningstar.

With an expense ratio of just 0.25%, the fund has plenty of fans among financial planners. "What's not to like?" says George Gagliardi, a planner based in Lexington, Mass.

T. Rowe Price Equity Income (PRFDX)

This fund, which focuses on dividend paying stocks, switched portfolio managers in 2015. But, says Morningstar, new manager John Linehan has maintained a focus on finding strong values. Top sectors include financial services – which constitutes almost 25% of the portfolio – as well as healthcare and technology.

James Bayard, a financial planner from Baton Rouge, La., said "consistency" is what he likes most about the fund. He also highlights its expense ratio of 0.65%, relatively low turnover, and the solid management team. "T. Rowe has a good process of spreading management duties around so they don't often fall into the 'star' manager issue and have planned transitions whenever a manager retires."

American Funds American Balanced F1 (BALFX)

Another fund in the mold of Vanguard Wellington, American Balanced holds roughly 60% stocks and 40% bonds. With an expense ratio of 0.65%, the fund has outperformed its benchmark, the Morningstar moderate allocation category, by almost 2% over a ten-year period.

Run by a team of 11 managers, the fund primarily invests in blue chip stocks and investment-grade bonds, with some of its top equity holdings including Microsoft, UnitedHealth Group, and Berkshire Hathaway, according to Morningstar. "I like that this fund has been very consistent," says Jeffrey Golden, a financial advisor from New York, NY. He adds: "The managers also have a lot of their own money invested in the fund alongside shareholders."

Dodge and Cox Stock Fund (DODGX)

Founded in 1965, this fund looks to invest in companies with good long-term growth prospects that are undervalued by the stock market, according to Morningstar. With its low turnover rate and 0.52% expense ratio, Dodge and Cox stock has returned 17.3% a year on average over the past 10 years, beating the S&P 500 by more than half a percentage point.

The fund, also on our Money 50 list of recommended mutual funds, relies on "bottom-up, fundamental research," often taking advantage of attractive valuations during a down market; however, once they do buy, they hold for the long term – for a weighted average of eight years, according to Morningstar. Its top sectors are financials and healthcare, with each accounting for almost 25% of the portfolio.

Kenneth Nuttall, a financial advisor from New York, says value is one of the few areas where active funds have a distinct advantage over passive ones. Dodge and Cox Stock is "a very good value fund that has a very repeatable process," he says.

T. Rowe Price QM U.S. Small-Cap Growth Equity (PRDSX)

Since manager Sudhir Nanda took over leadership of the fund in 2006, it has consistently outperformed its benchmark, beating the S&P 500 by 2.7 percentage points a year over the past decade. Started in 1997, the fund ranks potential investments based on valuation, quality, and momentum, leading to a broadly diversified portfolio of around 300 stocks. While Burlington Stores, Teledyne Technologies, and Heico Corp are top holdings, no stock represents more than 1.25% of the portfolio.

With its price tag of 0.79%, the fund is an attractive low-cost option for investors seeking active small-cap growth exposure, says Morningstar analyst Linda Mushrefova. It stands out for its steadfast "consistency," and for "taking on relatively less risk than its typical peers," she describes. And it has less turnover than other small-cap growth funds.