When it comes to investing you are pretty much faced with two choices, active or passive investments.
Active investment funds are where the fund manager will attempt to beat the collective market where he or she operates, whereas passive funds (also known as index trackers) track the overall returns for that market.
You may have gathered from previous articles that I am a big advocate of passive funds and the main reason for this is because the average passive fund MUST beat the average active fund. It’s a case of simple maths.
Passive MUST beat Active
To keep things simple, think of the stock market in two groups. Active funds on one side and passive funds on the other.
If we forget about costs for a minute, the average active fund return will be the same as the average passive fund return.
This is because all active funds are the market. Passive funds track the overall result of this market.
Now if we add costs back in, because active funds usually cost considerably more than passive funds, the average active fund will return less after charges.
This was explained categorically in Nobel Prize-winning economist William Sharpe’s 1991 paper and also communicated brilliantly by Robin Powell’s The Myth of Average Returns.
Don’t leave your investing to chance
Now the active fund management industry and supporters of it will argue that some active managers do beat the market (and with it passive funds) and this is true.
The problem is there is a massive weight of evidence that says after costs are factored in very few active funds beat the market over the long term, and if they do it’s very hard to pick these funds in advance.
I prefer to invest like a scientist. By using the evidence to make informed decisions. I don’t take a chance with the investments I recommend to clients and use the same investments for my own future wealth building.
If you would like to ensure you are on the right side of averages and ensuring high costs are not seriously damaging your wealth, then please get in touch for a no obligation chat at our expense.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
