Active vs. Passive Investing: The Wrong Question

There’s quite a bit of scholarship and media devoted to the issue of active vs. passive investing in stocks. The conclusion across the board is that passive investing is the sure winner. But that’s only a simplistic way to look at the choices. The studies comparing the two inevitably include a lot of funds that shouldn’t be considered. Specifically, high cost and captive funds (those sponsored by brokers and insurance companies and to which their clients are directed). As this piece from Morningstar.com points out, when you exclude these dogs, the results are very different. Active funds aren’t so bad when you look only at low-cost funds. Also, U.S. stocks, especially large stocks, are the most efficient market and most likely to favor passive investing. The picture changes when you look at other asset classes.

Quietly, Vanguard’s actively run funds have outperformed their more-famous index siblings. The very cheap active funds from other companies were somewhat behind Vanguard’s active offerings but were fully competitive with the company’s index funds. The costly funds lagged significantly, as expected.

The index funds’ average ranking of 44 may strike you as unimpressive. If so, that is partially because you have been oversold by index marketers, who like to imply that actively run funds outgain indexes over the long term as often as metal scavengers find long-forgotten gold hoards. The occasion is not nearly so rare. But there is also a legitimate explanation: Every Vanguard index fund from 15 years ago exists today, where as many losing competitors closed their doors and thus do not appear in this study. Vanguard’s index funds compete against the winners.