DIY Investor Magazine
/
December 2015
47
PASSIVE VS ACTIVE INVESTING
Active investors either pick individual stocks or put their
money into funds run by managers who aim to do better
than average, or judge the best times to get in and out
of different assets.
Fifty years ago, passive investing as we think of it
today didn’t exist, tracker funds had not yet been
invented and stock market indices were only used as
benchmarks. All investing was essentially active until
index funds were devised in the 1970s as academic
research revealed that the majority of active fund
managers failed to beat the market.
Their creators used mechanical rules instead of
expensive managers to construct index-following
portfolios at a fraction of the cost of active funds;
Exchange Traded Funds (ETF) are their modern
incarnation, covering all mainstream markets and asset
classes, making the construction of a diversified,
low-cost DIY passive portfolio a realistic prospect for
anyone.
PASSIVE INVESTING TENDS TO BEAT ACTIVE
INVESTING
You might think passive investing sounds rather
defeatist, but evidence shows most active managers do
not beat the market – or at least not by enough to cover
their fees – thus investors would achieve higher returns
if they’d simply tracked the index. When financial firm
Vanguard surveyed all the active funds available to UK
investors, it found that over 10 years 70% lagged their
ETFs are most often associated with passive index-tracking strategies, but they have a role to play for
investors trying to beat the market, too.
benchmarks; even successful fund managers’ winning
streaks don’t tend to last, which means investing in
funds that have been doing well recently is not a recipe
for success.
A passive strategy based on asset allocation and
regular savings avoids wealth-sapping bad behaviour
whereby investors buy funds when they’re popular and
the stocks they own are expensive or in fashion, and
sell them when they’re cheap and unpopular.
PASSIVE AGGRESSIVE
A range of ETF trading strategies exist for those looking
to beat the market:
•
Sector rotation - trading in and out of different
sector ETFs to try to exploit the economic cycle.
•
Theme-based investing – looking for ETFs that
track companies that you believe will outperform
because, for example, they are based around a
particular technology you like.
•
Tactical allocation – increasing exposure to cheaper
or more promising countries or assets, and
eschewing more expensive ones.
•
Short-term trading - for those who want to test their
mettle, trading ETFs can be cheaper than shares,
attracts no stamp duty and there can be
better liquidity.
The passive versus active debate comes down to
personal choice. There is evidence that most people
are best served with a passive, long term, investment
strategy, keeping a tight rein on costs; however, there
will always be those that are allured by the prospect
of beating the market. Perhaps the answer is that you
do both – make sure that the largest proportion of your
wealth is passively invested for the long-term and keep
yourself a small speculative portfolio for your market
call investing ideas.
ETFS AT A GLANCE
