Active vs. Passive Management
Categories: investing, wealth, stocks, mutual funds
“Wall Street Pares Gains as Bargain-Hunters Retreat,” Associated Press, July 6, 2010
Today we are focusing on stock investing only. Unfortunately, many of you out there read headlines such as this one and believe you must rush out and BUY OR SELL. After all, if the headline is screaming at you, it must mean something.
Act on the headlines at your own peril.
You might see your stock investment plummet, get nervous and want to ACT. Read on and see how being passive works out in the long run.
MAIN TOPIC: Why you Must Ignore the Investment Headlines
Raise your hands if you watch CNBC, Jim Cramer, or any investing program. Who here checks on their stock and mutual fund prices daily; and scours Yahoo Finance and MSN Money for financial news?
Now, don’t be shy, you know who you are. You think you are being very diligent and keeping up with the market and your investments. Well, you’re wrong.
- Are you trying to beat the market performance?
- Find the hottest stock?
- Get rich quick?
Stop right now. There is a better way, with a greater chance of yielding long term wealth.
In this class, you will learn:
- The historical performance of the stock market and why it matters.
- Stock market facts & what they mean about getting wealthy.
- How being passive leads to wealth.
PRACTICAL APPLICATION: Active Managers are Losers
Over 20 years, the S & P Index beat 68% of all actively managed funds.
In other words, most investors in actively managed mutual funds with “professional money managers” (who regularly bought and sold stocks) had worse returns than investors who stuck with unmanaged INDEX FUNDS.
Active managers believe they can outperform the indexes with their superior stock picking ability. In reality, any fund with an active manager(s) has higher costs than an index fund. That means right off, they have to beat the index substantially in order to cover their larger expenses.
Active managers frequently demonstrate superior performance for a year of two. Do you think it typically continues for the long term? NO it does not. Many research studies show that actively managed mutual funds with outstanding performance one year have subpar results the next.
Active managers are the ones who listen to the headlines and jump in to buy or sell based on “the news.”
This ACTIVE strategy yields long term UNDERPERFORMANCE.
The economy goes 
up and down and so does the stock market. Expect these ups and downs and do not be surprised by them.
Since 1960 there have been 9 Bear Markets (decline of 20% or more in the overall stock market). In spite of these declines, the S & P 500 had an annualized return of 10.05% from 1926 to 2007.
Let’s look at the Active vs. Passive investing debate another way.
HOW MUCH WEALTH MIGHT YOU HAVE EARNED BY INVESTING IN THE STOCK MARKET as represented by the S & P 500 Index?
Growth of $1.00 in S & P Index from 1980-2000In 1980, invest $1.00.In 2000, that dollar grows to $18.41That is equal to an annual compounded return of 15.68%; Definitely one of the most profitable times to be invested in the stock market.Suppose you were an active manager who missed THE BEST 15 MONTHS OF THE PERIOD. (Let’s say you were very unlucky and took your investment money out of the stock market for the best 15 months in the 20 year period).Without the best 15 months between 1980-2000, your $1.00 investment in 1980 would have grown to $4.73 or a compound annual return of 8.08%.Now an 8.08% return looks fairly attractive today, but in comparison with a 15.68% return, it’s poor.
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What about the longer term, does this theory still hold?
Growth of $1.00 from 1926-2000
In 1926, invest $1.00.In 2000, that dollar grows to $2,285.00Leave out the best 37 months, the $1.00 is worth $17.42 |
DO NOT JUMP IN AND OUT OF THE MARKET.
Do you know when the market will have the biggest increases? Of course not, no one can predict the future! The lesson is this; active management leads to worse returns than simple index investing.
TIME IN THE MARKET is the best way to get rich.
Start now and continue investing. Buy an index fund or two, continue with regular investing, and if history is any guide, over time you will become rich.
Investing terms:
Stock Market: Usually refers to an index of many stocks or bonds which serve as a proxy for the total stock market. The most common index for stocks is the S & P 500.
Active management: Buying and selling stocks or bonds in an effort to outperform the overall market.
Passive investing: Invest in index funds in order to minimize fees and expenses and match the overall market performance.
Are you an active or passive investor? How is your investing strategy working out?
ACTION STEPS:
Get a notebook and label it: “(your name) Personal Finance” and keep it by the computer. Use it to keep all of your personal finance goals, thoughts, activities, and plans.
Read this article before investing any money.
When you are ready to invest, commit to regularly contributing to a stock mutual fund as part of your overall investment plan.
Caveat: This article is for information purposes only and may not be appropriate for your individual situation.
YAKEZIE SHORT CARNIVAL:
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I no longer try and pick stocks. It’s a hard game in the long run. I’d rather just asset allocate.
B- Thanks for the mention and tweeting my contest! -G
I thought i was a genius when I first started investing in stocks. But I forgot the old adage that a rising tied lifts all boats (or idiots). I’d been lucky to invest in one of the biggest bull runs in history. I thought i could make 13-15% returns for ever. My story is more about idiots luck than anything. I fortunately sold out to buy a house about 6 months before the shine wore off. The adage should really be changed to a rising tide lifts all idiots.
I’m focusing on paying down my mortgage now when i finish i’ll be following a 55% bond, 40% index 5% direct investment (so I can have some fun)
Nice presentation. I work with individuals to show them how easy it is to do it themselves.
As with Benjamin I allow individual stocks with 5% max in a given name. Who can resist looking up Panera Bread after an initial visit ( not recommending it! Just an example).
Agreed. There are certainly a very, very small percentage of individuals who do beat the market. Typically it is a losing battle, way too much work, and entirely unnecessary. Why would anyone want to play this game with their retirement portfolio is beyond me? Perhaps, it is a difference in information (they don’t have or believe the data) or a difference in risk tolerance.
My husband started investing in stocks last year and has realized that investing in the stock market is a long-term option. He now has his “dream team” of stocks, all of which he has looked at from a historical perspective. Perhaps in 25-30 years we’ll see some good profit.
DIY, Roshawn, You all sound very wise. @ Sam, Asset allocation with index funds has so much research in it’s favor, long term, you will be better off than most. #Benjamin, how lucky to pull out at a peak. Paying off your mortgage gives great peace of mind and security! @ Shawn, as usual, you cover all of the bases. The time required to research individual stocks is tremendous, and the payoff is questionable. But, yes, there are many that do not believe the evidence.@Jennifer, tell hubby to check out NAIC, betterinvesting.org. If he is going to research and invest in indiv stocks, this non profit organization has great resources.
To all, thank you for continuing the discussion with your intelligent comments. Best regards, Barb
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My CNA education is finally over, now comes the harder bit of actually finding a job! Anyway, just wanted to say hi from a fellow nurse
heh, I love saying that!