This is post number five in our series, bringing us exactly halfway through our ongoing look at the most common investor errors.

This morning, we are going to briefly look at what may very well be the most common mistake investors make: Being active investors.

Passive vs Active Management

Active fund management – the attempt by an investor or manager to try to outperform their benchmarks through superior stock picking and/or market timing – is exceedingly difficult. It has been shown (repeatedly) that every year, 80% of active managers under-perform their benchmarks.

Those are not particularly attractive odds.

Worse, most active managers typically run higher-fee funds. (all that activity costs money!). That combination — High Fees + Under-performance — are not the ingredients of a winning long-term strategy. This is why for the vast majority of investors, passive index investing is a superior approach.

Why? You:

-Remove the emotional component
-Take advantage of (instead of working against) mean reversion
-Garner the lowest possible fees
-Eliminate all of the friction caused by overtrading
-Keep capital gains taxes as low as possible
-Get good results over the entire long cycle
-Avoids typical cognitive errors
-Stop chasing hot managers and funds


Consider if your portfolio won’t be better served replacing some or all of your active fund managers with passive indices.



Top 10 Investor Errors
1. Excess Fees
2. Reaching for Yield
3. You Are Your Own Worst Enemy
4. Asset Allocation vs Stock Picking


Top 10 Investor Errors
1. High Fees Are A Drag on Returns
2. Reaching for Yield
3. You (and your Behavior) Are Your Own Worst Enemy
4. Asset Allocation Matters More than Stock Picking
5. Passive vs Active Management
6. Mutual Fund vs ETFs
7. Not Understanding the Long Cycle
8. Cognitive Errors
9. Confusing Past Performance With Future Potential
10. When Paying Fees, Get What You Pay For

Category: Apprenticed Investor, Investing, Rules

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

13 Responses to “Top 10 Investor Errors: Passive vs Active Management”

  1. ezrasfund says:

    Many of my friends are big fans of Scott Burns and his “Couch Potato Investing”. But it’s not as much fun as active management, and what do you do with all of your spare time?

  2. faulkner says:

    Barry, I completely agree … and …

    Consider the language “Active vs Passive” and our species. We have a built-in bias for action. Who gets the position, the promotion, and the girl? The go getter. The idea of passively waiting out one of life’s more important decisions is an anathema – especially when it’s losing value. To not act when one’s wealth is being threatened is anti-survival. To not think, “someone must know how to do this” goes against all the rest of our experience of the world.

    A change of language might help nudge this a bit. Instead of “active vs passive,” perhaps “market driven,” “hands off” or “transparent” management vs “ego driven,” “too many chefs” or “opaque” management.

  3. Vitus Capital says:

    Agree & Disagree. If the active manager’s value add is supposed to be to provide alpha, then going for indexing wins. If, like us, your value add is to provide reasoned protection against the wonders of the new normal, then not. OTOH, we don’t drive the kind of cars BR is enamored of. :-)

  4. scottinnj says:

    Long story short once I was visiting at Vanguard’s HQ outside Philadelphia, and I happened to get the door the same time as John Bogle. I’m not normally awestruck but I did mention that I was an investor and appreciated all he had done to popularize low-cost index funds and to develop the unique structure at Vanguard. He was appreciative and just said “I’m also very happy when our shareholders are happy”. Truly in any investing hall of fame Mr Bogle deserves a prime spot.

  5. end game says:

    After taxes something like 95% of active funds underperform the S&P 500 Index. It’s like the theory of evolution; this debate was settled long ago. The real issue today is fundamental indexation vs. market capitalization weighted indexing. The inherent flaws of the S&P 500 cause it to lose 2 percentage points a year on average vs a non-market cap weighted index like “fundamental indexing”. It is malpractice that advisors have not gotten this advice out to their investor base. Pension plans have moved tens of billions into fundamental indexes — CalPERS alone has moved $3 billion — but brokers and individual investors remain clueless.

  6. [...] Why passive investing is preferable for most investors.  (Big Picture) [...]

  7. Iamthe50percent says:

    If 80% underperform, that means 20% equal or outperform.

    End game, what do taxes have to do with it? Active and Passive profits and dividends are taxed the same. Also, within a 401K or IRA, taxes are irrelevant.

    Barry, if I just buy the market with an index fund, why should I put my money with you?

    In a down market, buying an index is just guaranteeing a loss.

    Every time I put my money into the TSP into the giant low-cost TSP “C” fund, I have lost. Most of my individual stock picks have made money and I’m just an amateur following Peter Lynch’s advice to buy quality companies whose products I understand. That and tea-leaf chart reading on GLD and SLV on which I’ve done the best, betting on human stupidity.

  8. Iamthe50percent says:

    Hell, my wife who knows zilch about the market has done better than the indices by buying Wal-Mart, Walgreen’s and AT&T because she likes the stores and has owned AT&T forever.

  9. boveri says:

    Great advice on this one and I’d like to hear more on Asset Allocation, briefly covered yesterday, if possible.

  10. gordo365 says:

    Iamthe50percent – My wife who also knows zilch about the market was wiped out because she bought AIG (our insurance provider she likes), Enron (her brother worked there) and HP – she likes the printers. Not sure what that proves though… :)

  11. Iamthe50percent says:

    Touche, gordo365

  12. [...] Fees 2. Reaching for Yield 3. You Are Your Own Worst Enemy 4. Asset Allocation vs Stock Picking 5. Passive vs Active Management 6. Mutual Fund vs ETFs 7. Neglecting the Long Cycle 8. Cognitive [...]