What is an index fund?
What is an asset class fund?
Should I invest in index funds?
What types of index funds should I invest in?
With tens of thousands of investments to choose from — and more appearing every day — the decisions you face are overwhelming and endless. But we believe all these decisions boil down to two primary choices:
1. Active Management vs. Passive Management
2. Indexing vs. Asset Class Investing
How you address these two decisions can have a substantial impact on your portfolio and its long-term financial success.
The difference between active and passive investing can come down to one thing: efficiency.
Active management assumes the market isn’t completely efficient — that some securities are over- or underpriced and it is possible to figure out which ones they are. Active managers try to beat the market through security selection and market timing. To do this, active managers must take on more risk than the market’s inherent risk.
On the other hand, passive managers aim to capture the market’s returns, investing without regard for future forecasts. Passive managers seek to avoid unnecessary risks and focus on keeping costs low in order to provide investors with greater potential returns. As the Nobel Laureate in Economics, William Sharpe conclusively demonstrated in a ground-breaking paper:
“…it must be the case that
1. before costs, the return on the average actively managed dollar will equal the return on the average passively managed dollar and
2. after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar
These assertions will hold for any time period. Moreover, they depend only on the laws of addition, subtraction, multiplication
Looked at in the clear light of simple mathematics, after fees and costs are deducted, active management becomes a losing game in which the expected outcome is negative, in which the odds are stacked against the average participant. In other words, while some active managers will win, the majority will necessarily lose. The math is inescapable, so it isn’t surprising as the chart below shows, over the last five years, most active managers underperformed their benchmarks.
Click Here to view the Wealth Guide Index Funds vs Asset Class Funds
Welcome to Solid Rock Wealth Management
Chris Nolt
President