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Index Investing Versus Active Investing
The index versus active investment debate is almost as old as the investment industry itself.
Active investing sounds impressive, while index investing sounds lacklustre. But index investing should rightly be called common sense investing, or evidence-based investing.
Looking at the evidence, it’s easier to be a supporter of index investing than active investing.
Index investing makes promises it can keep – it aims to give investors the market return. On the other hand, active investing claims to beat the market. But it often doesn’t.
Most active managers are unable to reliably beat the market return. The table below demonstrates how.
Percentage of large cap funds that underperformed their local equity index to June 20181
|Over 5 years||Over 3 years||Over 1 year|
Not sure how to find a high-performing fund? Out of 550 domestic equity funds that were in the top performance quartile in September 2016, only 7.09% were still in the top quartile at the end of September 2018.
Few, if any, can outperform the market on a long-term basis. Despite this, active funds charge higher fees. This can also impact returns.
Why can active funds rarely be sustained? Because they rely on the active manager being able to see the future. That’s a big ask in a world with many uncontrollable factors. Not only do predictions go awry, but fund managers can also mistake the market.
More people are seeing the wisdom of the index investment approach. It makes sense, and it’s supported by evidence. Investing broadly in a market and keeping fees and expenses as low as possible is more likely to be rewarding over the long haul than chasing an illusion.
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2 Large cap US equity funds underperforming the S&P 500 (data ex SPIVA)
3 Australian equity funds underperforming the S&P/ASX 200 (data ex SPIVA)
4 Europe equity funds underperforming the S&P Europe 350 (data ex SPIVA)
5 SPIVA Persistence Scorecard September 2018