Personal Finance Essentials
The Two Ways to Manage Your Investments
Do You Want to BE THE MARKET or
Do You Want to BEAT THE MARKET?
The S&P 500 Stock Index has earned an average of 10% per year since 1926. So you have a choice: you can invest in a way that gets the market return – whatever it is – or you can invest in a way that tries to beat the market return. Do you want to be the market or beat the market? In the world of investment management, this is known as the difference between passive and active investing.
Passive investors buy mutual funds and exchange-traded funds that replicate the stock and bond markets. Active investors buy investments they think and hope will outperform the overall market.
What the Data Shows
The answer to which approach is better is provided by decades of performance data, compiled by the SPIVA (S&P Indices Versus Active) Scorecard: 80% of stock funds and 50% of bond funds underperformed their benchmarks over the 10-year period ending December 31, 2024. Not only do actively managed funds fail to produce as high a return as passive funds – they cost more, take higher risks and generate bigger tax liabilities for investors. And passive investing is simply easier, because you don’t have to pay as much attention to your portfolio.
The gap between what funds earn and what investors actually receive tells an equally sobering story. According to long-running research into investor behavior, the average investor in diversified stock funds earned only 3.8% per year over a 30-year period, while the funds themselves averaged 10.7% per year. Investors captured only about 36% of the returns available to them, largely because they were buying when prices were high and selling when prices were low. This data makes a compelling case for passive investing – staying invested, keeping costs low and letting the market do its work.