Should You Be An Active or Passive Investor?
There’s a neverending debate in the investment world about whether it’s possible to beat the market by actively picking individual stocks (whether on your own or through actively managed mutual funds) or whether you’d be better off just sticking with a low-cost index fund that simply tracks the market.
At first glance, it seems better to try to beat the market.
The problem is that this is incredibly difficult.
The vast majority of mutual funds fail to do so in the long run and those that do are unlikely to continue doing so in the future.
So why do stock market indexes outperform?
There’s nothing magical about stock market indexes that cause them to do better than mutual funds.
Rather, the Efficient Market Hypothesis is that stocks are all fairly efficiently priced to have a similar expected rate of return for their level of risk and that the main difference in returns comes from a combination of randomness (whose effect tends to diminish over time) andcosts like management fees and trading costs.
By minimizing those costs, index funds can capture more of that return.
The leading counter to that is the idea that “value” stocks can outperform the market in the long run.