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Active vs. Passive Investing

February 28, 2013

Active investors try to beat the market averages.  Passive investors are satisfied duplicating the averages.

 

Active investors trade extensively trying to find undervalued gems buying from, and selling to, others trying the same things. One person’s gold is another’s dross, or vice versa.  Active investors usually pay more taxes, because of greater turnover of selling of stocks with gains, are susceptible to style drift, paying more fees and brokerage costs, and need to take greater risks to try to outperform the market.  Active funds need to overcome their added costs and taxes before even measuring performance.  Note that taxes are not a factor with tax deferred accounts.

 

Passive investors own index funds or ETFs that trade little which makes them much more tax-efficient with very low costs.

 

During the market meltdown at the end of 2008 and beginning of 2009, virtually all of the major stock indexes and active mutual funds dropped similarly showing that it didn’t matter what you owned and that those in the market aren’t protected from a broad based drop.  Style and selection did not seem to matter.  If you look at the three major indexes – the Dow Jones Industrial Average, the S&P 500 and NASDAQ – over any reasonable period you will see they usually have graphs that follow the same ups and downs (although overall long-term performance does vary between those indexes).

 

Many actively managed mutual funds beat the averages, but just as many do not.  Few of those that beat the averages do so consistently over a sustained period.  And these are handled by the best in the business.  Passive fund investors are satisfied accepting the market ups and downs while shunning trading judgment, management risks and higher costs.

 

Next time you are ready to buy a stock or mutual fund – consider passive.

 

FYI, some major exchange traded funds are:

 

Index Description Ticker Symbol Known As
Dow Jones   Industrial Average 30 large companies DIA Diamonds
Standard & Poor’s 500 Average 500 of the largest   companies SPY Spiders
NASDAQ 100 100 major NASDAQ   stocks QQQ Ques
RUSSELL 2000 2000 small-cap stocks IWM
Wilshire 5000 5,000 equity   securities VTI Vipers
S&P 400   Average 400 mid-cap companies MDY Mid-cap spiders
MSCI EAFE European,   Australasian and Far Eastern markets EFA
S&P   Global Materials Commodity related   mfg. MXI

 

A related blog is at https://partners-network.com/2012/05/08/even-apple-is-human/

2 Comments leave one →
  1. shalomray permalink
    February 28, 2013 2:05 pm

    An investment advisor once told me that the worst thing to ever happen to the individual investor was CNBC. Too much information leads one to think that there is a magic way if only one could find it. 12/7 media coverage of the markets absoutely reinforces this (incorrect) assumption and bolsters the casino image of the financial markets. Passive investing counters this and should work well over time.

    ironically, those who invest actively are often the ones who crave home runs but can’t stomach the strike outs. Passive investing will lead to its share of strikeouts (like the market meltdown of 2008-2009) but, through a series of singles and doubles over the years, should produce acceptable returns to help your reach your goal.

  2. February 28, 2013 3:04 pm

    Thanks Ray, right on the mark.
    The regular investor should want to be in the market so they can share in the growth of the economy as reflected in the prices of stocks over time. If they want to make a killing they should realize it can only occur if they put all their money in one stock which then goes up. Of course that is very risky since the stock could also go down. Once they stray into a second or third stock they reduce risk, but also the ability to make a killing. With five stocks they approach market averages, so why not just invest in the market – with index funds.

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