There are two kinds of investors. Passive and active.
This is somewhat of an oversimplification, but essentially there are those who believe in owning broadly diverse funds with low administrative costs and holding them for the long-term—versus those who believe in buying stocks that show signs they’re about to go up and selling stocks that look like they’re going to drop, making money in the short-term.
While the former, passive, philosophy has been gaining in popularity, the latter, active philosophy is certainly a lot more exciting. In the popular financial media, you almost never hear the names of passive fund managers, while on a daily basis you’re kept up-to-date on the latest moves of so-called star active managers who are buying or dumping huge stock allocations based on short-term outlooks.
Not only are the exploits of the active managers more interesting, but they always seem to have a good reason for what they do. And when one of these funds chalks up a good year or two, you might wonder if you’re missing out on something.
Careful analysis shows you’re not.
Last year, economist Moshe Levy published a study in The Journal of Investing in which he evaluated the performance of all U.S. actively managed equity funds for the thirty-year period of 1991 – 2021. Importantly, his analysis accounted for survivorship bias, the tendency to omit the performance of funds that no longer exist because they’ve gone under.1
Levy found that over the past three decades more than 92% of active funds did not perform as well as the S&P 500. And even more striking, he showed that the aggregate annual loss to investors in these was $235 billion ($186 billion in inefficient allocation and $49 billion in fees).
So why do people keep handing their money over to active managers? Levy concluded, “When choosing funds, investors attach too much weight to historical returns.”
Financial author Larry Swedroe took Levy’s data, and after calculating the difference in fees between active and passive investing, wrote, “Active investors have engaged in a massive transfer of wealth—about $80 billion annually, based on the then-market capitalization of about $12 trillion—from their own wallets into those of the purveyors of actively managed products and market makers.”
The point is not that active management is dishonest or does not play some role through its “price discovery” in the efficient allocation of capital. It’s just not the most prudent way for the average investor to grow his or her nest egg over the long-term.
Because saving for and living through retirement is a process that takes decades, things like inflated fees and unnecessary risk can have a sizeable effect over time. It’s in your self-interest as an investor to follow the strategy with the best potential for meeting your retirement goal. And that includes the guidance of a trusted advisor to help you adjust your plan along the way and hold you accountable to your future self.
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Disclaimer:
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