Here’s another controversial topic – passive versus active investing. And right at the start of this discussion I’ll tell you that a believe in a hybrid approach: some passive and some active investments.
Time and again, individual investors have discovered how difficult it is to predict the next winning stock or the market’s next turn or cycle. And active investing by the small guy has been called a loser’s game, according to Charlie Ellis.
Recently we’ve seen that two-thirds of the actively managed mutual funds under-perform their benchmarks over a 5 year period – and that both individual investors and the investment professionals lose more ground when they try to time market by altering their asset allocations. Academic studies have shown that the more individual investors attempt to beat the market, the less chance they have of doing it.
So, the alternative lies with passive investing – which is about reaching your investment goals by selecting the right asset mix for your needs, limiting your trading costs by owning ETFs and index funds, and rebalancing the portfolio only occasionally to return to its target allocation. This method has been shown to consistently outperform active investing on an after-cost, after-tax risk-adjusted basis.
John “Jack” Bogle (and his Boglehead followers) believes that passive investing provides investors with the best opportunity to achieve their financial goals. This isn’t likely to make you the most popular person to talk to at the neighborhood party, but passive investing might make you the savviest investor on the block. It is hard for most people to believe that a passive approach is better than an active approach – since we have been trained to think that the harder we work, the better the outcome; however, it is the opposite when it comes to passive investing!
If you don’t want to take the full plunge by owning only index funds and ETFs – you can invest in shareholder friendly, fundamentally solid mutual funds. Avoiding high cost funds and those that charge entry and exit fees can help you preserve more of your capital.
Another approach is to use passive index funds for large cap stocks and an active approach for mid- and small cap stocks. Whatever approach you take, be aware that you should think about your after-tax and after-transactions cost return. In the long-run you’ll be glad you followed this advice.