Index Fund Advantages
Index Funds are capable of performing better than an actively managed fund because
1) Index Fund managers trade less than actively managed funds. At the end of a year, actively managed funds retain only about 15%(data from http://www.fool.com) of the shares that they had during the start of the year. The cost of these transactions makes the return smaller by increasing the expense ratio of the fund.
2) Also in order to ‘time the market’, a percentage of the funds portfolio is held as cash. This brings down the total return on the portfolio.
The disadvantages are
1) The stocks in the index are bought even when they shouldn’t be e.g. at P/E >50 like around 2000.
2) Indices work best when their components are trending (like they did between 1982 and 2001). For instance, much of the S&P500 is made up of a few handfuls of large cap growth stocks. When those are tanking, the index stays flat despite there being opportunities elsewhere.