Why Passive Investing Makes Sense

The debate about active versus passive management is endless in investment management circles, but here are a few simple facts in favor of passive management.

  1. Missing opportunity? Strong performance among a few stocks accounts for much of the market’s return each year. There is no evidence that active managers can identify these stocks in advance and attempting to pick them may result in missed opportunities.For all U.S. stocks from 1926 thru 2011, the compound average annual return was 9.6%.If you didn't own the top 10% best stocks each year, your return was 6.2%. A huge difference!If you didn't own the top 25% best stocks each year, your return was -0.7%. Ouch!
  2. The majority of active public equity funds do not beat their respective index. According to Standard & Poor's, the following percentage of actively managed funds did not beat their respective index for the five-year period ending December 2011:
    • 62% U.S. large-cap funds
    • 80% U.S. mid-cap funds
    • 73% U.S. small-cap funds
    • 63% Global funds
    • 78% International funds
    • 26% International small fund
    • 83% Emerging markets funds
    • Superior performance is not persistent. Of the top 25% U.S. stock funds from 2002 to 2006, for the following five-year period from 2007 to 2011:
    • Only 8% remained in the top 25%.
    • Only 18% remained in the top 50%.
    • 21% fell to the third quartile of performers (51% to 75% range)
    • 46% fell to the bottom 25% of performers.
    • 15% didn’t survive (the fund was merged or closed)

Passively managed funds have a very high relative predictability to match their benchmarks and not underperform.

These few simple facts lead to a successful long-term investment strategy.

About Bruce J. Berno, CFP®

Bruce J. Berno, CFP®is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.