Posts filed under “Apprenticed Investor”

Only Human: Passive Still Beats Active Investing

Yes, it remains true: Indexing is a better strategy than active investing. Passive beats most Humans. Various academic and market studies continue to demonstrate this:

"This year through September, only 28.5 percent of actively managed large-capitalization funds — which try to beat the market through stock selection — were able to outpace the S.& P. 500 index of large-cap stocks, according to a new study by S.& P. In the third quarter alone, it was even worse, with only one in five actively managed large-capitalization funds beating the index.

That isn’t terribly surprising, said Rosanne Pane, mutual fund strategist at S.& P., because active managers tend to have difficulty beating indexes when market leadership changes. And in the third quarter, many stocks that had paced the market for much of this decade began to fall behind. Small-company stocks were finally beaten by shares of big, blue-chip companies; sectors like energy also started to lose ground.

Still, such transitional periods aren’t the only good times for indexing. S.& P. research shows that while active management fared poorly in the third quarter, it has actually been lagging behind the indexes for a considerable period.

Over the five years through the end of the third quarter — a span that included both bull and bear markets — only 29.1 percent of large-cap funds managed to beat the S.& P. 500. What’s more, only 16.4 percent of mid-cap funds beat the S.& P. 400 index of mid-cap stocks, and 19.5 percent of small-cap funds outpaced the S.& P. 600 index of small-company shares. “The long term does seem to favor the indexes,” Ms. Pane said."

Why do investors bother? Aside from the few who are unaware of the research, my guess is many are attracted by the glory of being part of the 65% that manage to beat the market every so many years: 

Beating_spx

Source: Standard & Poor’s; Data thru 9/30/06

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For the rest of the time, we all want to be special — in the 20-40% or so who do manage to outperform the indices most years.

 Of course, it’s likely a different 20-40% each year, and is more likely a function of style or asset class (Emerging market, Small Cap, Value, etc.)

Yes, that’s right:  another example of how when your emotional side trumps your rational side, you forfeit gains. Don’t be too hard on yourself, you are only Human.

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Source:
If You’re Playing ‘Beat the Benchmark,’ Don’t Expect to Win
PAUL J. LIM
NYT, October 29, 2006
http://www.nytimes.com/2006/10/29/business/yourmoney/29fund.html

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