John Cameron's personal blog

Serious discussion about your financial position now - and in the future.

5 Things To Think About When Choosing Between Active And Passive Investment.

One of the most hotly debated areas in investment is whether you should invest in actively managed funds, or index funds. As is often the case, these debates often generate much more heat than light.

The difference is that actively managed funds seek to select assets (let’s focus on shares, but the same principle applies to other asset classes such as bonds), whereas index funds simply look to track a given index and buy shares to mirror the index, without worrying about the merits of any particular company.

Let’s look at the logic.

1. The argument for index investing is that, over the long term, it is very difficult, on average for any actively managed fund to beat the index.

2. However, there are two weaknesses to this argument, so far as individual investors go. They are “long term”, and “on average”.

3. Firstly, the term “long term” is never defined, and there is plenty of research showing particular funds outperforming their index over many years, even decades. Having some plan that includes your own time horizon is a useful tool when selecting funds.

4. So far as “on average” goes, it is hardly surprising that funds cannot “on average” beat the market. After all, there are hundreds of them, and in aggregate, they dominate the market. In a very real sense they ARE the market. So, for funds to beat the market “on average”, they would have to beat themselves. Pardon?? If that isn’t circular logic, what is?

5. More on the subject of averages. Given there are hundreds of funds out there, you can safely assume that at a given time about half (more or less) will be beating the market, and about half trailing it. In other words, plenty to choose from.

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