When it comes to investing in stocks and bonds, you might be wondering whether active or passive strategies are better. Generally, passive investing, especially through index funds, tends to outperform active management over the long run. This is mainly because it’s really tough to consistently beat the market indices.
Back in 2012, I decided to leave my job in institutional equities, largely because the industry was changing. Technological advancements, like algorithmic trading, were squeezing trading commissions. Also, active money managers were seeing a decline in assets under management due to their underwhelming performance. It became clear that passive investing was gaining the upper hand.
Over the years, the gap has only widened. Passive fund managers have seen a significant increase in assets, while active fund managers have struggled. The nature of passive management is straightforward—there’s no real analysis involved. Passive managers simply track their benchmark indices, making the same changes whenever the indices do.
As of 2023, passively managed equity funds hold about 45% of the market, while passive bond funds have about a 25% share. These numbers are expected to grow.
Let’s delve into the actual performance numbers, which are quite revealing. For example, the SPIVA U.S. Scorecard has been tracking the performance of actively managed funds against their benchmarks since 2002. The data is clear: most active managers in both equity and fixed income do not outperform their benchmarks after fees.
When you look specifically at equity funds, the picture is even grimmer. For instance, over 90% of active equity funds in categories like Large-Cap Core Funds underperform. The best-performing active funds are generally those investing in international markets or in smaller companies, but even there, the majority underperform.
Interestingly, 2018 was a relatively good year for Mid-cap Growth funds, which outperformed their category despite overall market declines. But this is an exception rather than the rule.
In fixed income, the story is a bit different but not by much. Some categories like California municipal debt funds initially show promising performance, but once fees are considered, their performance relative to benchmarks worsens significantly.
Fees are a huge factor in fund performance, particularly in fixed income, where returns are generally lower. This makes the impact of fees even more pronounced. High fees are one reason why hedge fund managers and venture capitalists can get so wealthy—they charge high percentages of assets and profits.
Despite these insights, people continue to invest in actively managed funds, often driven by hope, clever marketing, and the prestige associated with certain managers. It seems easier to trust a fund managed by someone from a prestigious background than one simply tracking an index.
However, if you’re looking for a wise investment strategy, putting the majority of your assets in passive funds is advisable. This approach minimizes fees and aligns more closely with market performance. It’s also worth diversifying into real estate or other stable assets to balance your portfolio.
Remember, managing your investments well is crucial. Tools like wealth management systems can help track fees and manage your asset allocation effectively. In the end, consistent investment and attention to fees are key to growing your wealth over time.
