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Active vs Passive Investing Cover

Active vs Passive Investing

If you’re a frequent reader of this blog, you should probably know by now that I’m a strong supporter of Passive Investment and Exchange Traded Funds. This post with +20’000 Views is an example.

There’s an ongoing debate about whether if active investing is superior to a simple lazy portfolio or if an active fund is superior to a low-cost ETF.

Are you good enough to pick the top stock that will beat the market? Or do you have absolutely 100% sure that you know a good active manager that will beat the market for the coming years? Will you know the answers to those questions consistently?

The Definitions

Active Investing: An active investor tries to beat the market. And basically, there are two ways. First by picking himself the stocks, bonds or whatever he thinks will beat the market. Another way is to choose a “professional” fund manager to actively manage their investments on their behalf.

Passive Investing: A passive investor tracks a market index. Therefore the idea isn’t to beat the market, but rather to have the return of the market minus expenses. Consequently, the investor invests in an index fund (a.k.a. ETF – Exchange-traded Fund). Whenever these indices switch up their constituents, the index funds that follow them automatically switch up their holdings by selling the stock that’s leaving and buying the stock that’s becoming part of the index.

These are definitions in very simplistic terms, because today you have nuances and a bit more complexity on how you define active or passive. For example: if you choose to buy an ETF that follows S&P500, or MSCI World Stocks, aren’t you making an active decision about the future outcome of stocks (in terms of how successful a region will be)? But let’s leave this part out of the equation for now.

How is This War Going?

Not good for active investing. There’s a growing trend of money from investors going to passive vehicles such as index funds. Therefore big investing companies are creating more ETFs to meet this demand.

More money in low-cost passive funds lowered the average fee paid for both active and passive funds. According to report from Morningstar the average management fee fell almost 45% since 1996.

And Returns?

Even worse…for active investing. If you read the SPIVA Scorecard, the results are enlightening. If you look at the US 2018 Scorecard, for example, Report 1 “Percentage of U.S. Equity Funds Outperformed by Benchmarks” you’ll see that the majority of U.S. Equity Funds are outperformed by its benchmark.

In a 15-year time frame, almost all the categories have a +90% percentage of funds outperformed by the benchmark. The longer the time frame, the harder it is to find the active manager/fund that beats the market.

And the sample contains thousands of funds. Also with survivorship bias accounted for. Thus you had to not only get it right about the manager, but you would also have to get it right about the fund surviving in the long-term.

Don’t look for the needle in the haystack. Just buy the haystack!

Jack Bogle

Next time you make a decision about active or passive, don’t forget to take a good look into the evidence that we already have. The last one to bet against passive investing didn’t end so well.

From twitter:

About GTRetire

GTRetire is the founder of GrowtoRetire, a blog about financial independence and early retirement. Click here to learn more about starting a blog! Also, this post may contain affiliate links, please read the disclaimer for more info.

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