Active vs. Passive Investing

Active vs. Passive Investing

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 atthe 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:

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