Why Index Investing Isn’t Passive Investing
An important article as a reminder that proponents of index investing painted alot of advantages of it over active investing. However, the main advantage that i see is drastically low annual cost compare to active funds. If you buy and hold indexes, your returns will depend on how well the index does, which eventually means that index investing != better returns.
In the debate over active vs passive investing, the base-case assumption is that a passive investment involves tracking a stock-market index, normally the S&P 500. But of course stock-market indices are actively managed, with listing requirements and changing components and survivorship bias and that kind of thing. And according to a fascinating paper by Angelo Ranaldo and Rainer Häberle, actively-managed indices significantly outperform a genuinely passive buy-and-hold strategy.
More precisely, actively-managed indices outperform a passive buy-and-hold approach in up markets, and they underperform in down markets. But since the whole point of investing in stocks is that they tend to go up over long periods of time, one can conclude that there is a real outperformance here over the long term.
I’m not sure how the efficient markets hypothesis deals with this: as you can see from the table above, the degree of outperformance is large. And I don’t think it’s a self-fulfilling phenomenon, either, where the very fact of being included in an index causes a stock to outperform: the same phenomenon is seen in relatively unpopular indices which aren’t benchmarked.
But this is yet another reason to buy index funds rather than individual stocks. If you buy and hold your stocks like any good long-term investor should, you have to outperform substantially just to keep up with the index, let alone beat it.
Related posts:
- The Active vs. Passive Debate Moves To Global
- Warren Buffett: Low Cost Funds win out
- Do new index stocks bring better returns?
- Craig Israelsen: An Alternative To Alternatives
- Passive Wealth Generation: From Zero to a Million Dollars in Five Measured Steps
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