Performance matters when it comes to investing. One question that is often asked when it comes to investing is: Active vs. passive investing, which is better?
For many years we’ve watched thousands of individuals invest, and the vast majority who tried to make money by picking hot stocks or by market timing end up hurting themselves more than they helped themselves. Sometimes badly. That’s why we generally believe individual investors are better served by a primarily passive approach.
What is the Difference Between Active & Passive?
Active investing generally involves attempting to generate superior returns by picking specific securities or timing the market by shifting in and out of various asset classes.
Passive investing usually involves determining a long-term asset allocation and then using a low-cost indexing approach to maintain that allocation.
While many people believe that active investing is far more exciting – especially with its imagined potential for “beating the market” – the main problem with active management and stock picking is an astounding lack of success. While the financial industry spends millions of dollars promoting active products that promise to outperform the market, even professional active managers rarely beat their benchmark over the long term.
To be fair, there are mutual fund managers with the great track records. Unfortunately, past performance is not predictive of future performance. With more than 10,000 mutual fund managers out there today trying to beat the market, statistics dictate some of them will perhaps outperform the benchmark. The problem is that this is an “in-sample” analysis; there is no statistical evidence that any of them will be able to repeat good performance in the future.
To learn more about active vs. passive investing and how it fits into your long-term financial goals, read our free “Personal Capital’s Guide to a Better Financial Life.”
Craig Birk, CFP®
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