SMART MONEY DIARY
Why Passive Investing
Why Almost Everybody Could Beat Professional Fund Managers in the Long Run
By performing passive investing into a globally diversified portfolio of low-cost index funds via ETFs, investors following a long-term buy-and-hold approach can even beat professional fund managers in the long run. The outperformance of passive investing versus active investment funds (mutual funds) is coming mainly from failed market timing, fund management fees, trading costs as well as capital gains tax connected with active trading and market timing and have all the same effect on an investor's portfolio: lowering its return.
Underperformance of Active Investment Funds in the US
Have you heard of the S&P SPIVA Scorecards for markets around the world? The S&P Dow Jones Indices SPIVA (S&P Indices Versus Active) Scorecard is a report that compares the performance of actively managed mutual funds to the relevant benchmark indices. The scorecard provides a comprehensive look at how actively managed funds are performing relative to their benchmark indices, and it is widely used by financial professionals and individual investors to evaluate the performance of active fund managers.
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​The SPIVA Scorecard covers a range of asset classes, including equities, fixed income, and alternative investments, and it is published on a regular basis, typically semi-annually or annually. The scorecard provides information on the percentage of actively managed funds that outperformed their benchmark indices in a given time period, as well as the average return of actively managed funds relative to the benchmark indices.
The SPIVA Scorecard is a valuable resource for investors who are considering actively managed funds, as it provides insight into the historical performance of these funds and how they have performed relative to their benchmark indices. Additionally, the scorecard can be used to evaluate the performance of specific fund managers, as well as to assess the overall trend in the performance of actively managed funds over time.
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Without supporting data it would be hard to believe, but SPIVA Scorecards measure how active funds performed against major benchmark indices like S&P 500: Very poorly.
One important key finding: The longer the chosen investment period, the worse the underperformance of actively managed investment funds.
Underperformance of Mutual Funds in the US
According to S&P SPIVA results from June 2022, for the US almost 90% of active investment funds underperformed the S&P 500 over a time period of 15 years. How do you want to make sure to pick an investment funds from the 10% of out-performers? Better play lottery.
Source: S&P Global - June 2022
Underperformance of Active Investment Funds in Europe
How do European mutual equity funds perform compared to their index benchmark in the long run? In short, not better. According to data from June 2022, the SPIVA Scorecard for Europe shows that almost 88% of active investment funds underperformed the broader S&P Europe 350 over a time period of 10 years.
Source: S&P Global - June 2022
Passive Investing Is Superior to Active Investing in the Long Run
According to the SPIVA Scorecards most active investment funds lag behind their benchmarks with regards to performance. Then, why to invest into active investment funds? Why not simply following a passive investing approach into broad market indices directly via low-cost exchange-traded funds (ETF)? The only thing that matters in the end is the accumulated value of your assets in your portfolio.
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Conclusion: Investing into the benchmark via a passive index funds (ETF) should be a smart idea.
Impact of Fees on Performance of Investment Funds
Often financial advisors are calling fees as moderate to low when informing a client about a 1.5% p.a. total expense ratio (TER) for an investment product they want to sell. At first glance, the difference between 1.5% and 0.4% seems not too high, indeed. But over a period of 30 years (remember, buy and hold) the outcome is significant. Let's assume, you want to invest 1,000 EUR (or USD) for your after-work life and have two products with identical performance of 6% p.a. to choose from:
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Active Funds - 2.5% agio (one time fee when buying) and 1.5% p.a. TER
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Passive Funds - 0% agio and only 0.4% p.a. TER
Source: Smart Money Diary - December 2022
Would you have expected a difference of almost 1,500 EUR (or USD) in asset value after 30 years?​ In this example, the exchange-traded fund with 0.4% p.a. has generated 40% more than the professionally managed funds. Even small differences in fees make a huge difference over time.
Now, imagine how the difference would have looked like if you had invested a 100k. Such a simple example should be eye-opening for every investor and support the argument to follow a passive investing approach based on low-cost ETFs.
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"Where returns are concerned, time is your friend.
But where costs are concerned, time is your enemy."
John C. Bogle
And guess what the funds industry is using the generated fees also for: active marketing and sales commissions for banks. Overall it is a well-oiled money making machinery - even "independent" investment magazines live well from ad placements financed by major investment companies. Therefore, do not expect too many critical voices about the business model of active investment funds.
More Insights into the Investment Funds Industry Needed?
Still not convinced that a passive investment approach might be the better choice? Then have a look at the following documentary movie called "Passive Investing: The Evidence the Fund Management Industry Would Prefer You Not to Know". It provides further strong arguments for following a passive investing approach. Enjoy!