Active vs. Passive Investing
“Wall Street Pares Gains as Bargain-Hunters Retreat,” ~ Associated Press, unknown date
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. If the headline reports, then it must be important.
Act on the headlines at your own peril.
You might feel compelled to act when your stock investment falls. You might believe that you know just the right time to buy or sell. Unless you’re a fortune teller, you’ll probably be wrong.
See how passive investing has beaten an active investing approach in the past.
Passive Investing and Ignoring the Headlines
Do you watch CNBC, Jim Cramer, or any investing program? Do you look at your stock and mutual fund prices daily? What about the financial news? Are you addicted to Yahoo!Finance, Money.com, WSJ.com and MSN Money for financial news?
You may 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 mini-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.
Active Managers are Usually Losers
Over 20 years, the S & P 500 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.
Let’s look at the Active vs. Passive investing debate another way.
This infographic shows a slice in time of the investing markets, 1980-2000 and compares a passive investing strategy with a worst case scenario active approach.
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 sub-par results the next.
Active managers are the ones who listen to the headlines and jump in to buy or sell based on “the news.”
In general, an active investing strategy under-performs passive investing in index funds.
The Economy and the Investment Markets Go Up and Down
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.
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 build wealth.
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 wealthy.
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.
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.
A version of this article was previously published.