Passive investment funds have stolen ground from active managers in recent years. Trillions of investment dollars now lie in pools designed to mimic major indexes. These pools are tended by mega-asset gatherers charging only a fraction of what active managers charge. In the recent run-up these past five years, passive funds have outperformed all types of active managers.

Passive Investment By The Numbers

Since 2011, passive exchange managers, including State Street, BlackRock, Charles Schwab and Invesco equity share prices have made a 23.4 percent average annual gain, while active equity fund managers T. Rowe Price, Eaton Vance, Franklin Resources and Legg Mason share prices delivered an average annualized gain of 9.9 percent over the same span, according to Ned Davis Research of Florida. By contrast, the Standard and Poor’s index gained on average 16.9 percent annually. Clearly investors believe that the prospects for passive managers are greater.

Ned Davis Research also reports that active manager growth has been stagnant rising from $2.1 trillion to $2.6 trillion between September 2011 and February 2017. Much of this growth was due to market appreciation. Passive managers grew from $655 billion to $1.6 trillion.

It’s almost as if investors have found their own elixir of success much like the “Nifty-Fifty” stocks back in 1972, a group of growth stocks that history had proven grew in good times and bad. The idea was set it and forget it—don’t worry about overvaluation. Like most fads, that formula ended in disaster.

According to Boston-based DALBAR, the 2017 performance sweepstakes proved extremely close. In that year the Standard and Poor’s 500 Index rose 21.83 percent, the average passive equity index fund investor made 21.34 percent.

But what do today’s passive funds provide for those ultra-low fees, and what do investors forego when they buy in? This is a question that should be on the mind of every investor responsible for placing money for themselves or others. In essence, what is the true cost of passive investing?

Passive Funds vs. Active Management

Passive funds use a passive investment strategy aimed at simply matching the returns on an external index like the Russell 2000, or the Standard and Poor’s 500. These pools of securities typically require little or no trading other than rebalancing—when stocks are moved into or out of the index.

Active management involves discretionary securities trading done in anticipation of market turns; active managers follow rules laid down in the prospectus or stated investment philosophy, but they are designed to protect their investors’ capital—ideally putting them ahead of their own interest. The fiduciary duties require managers to put their customers first. They are, in essence, guardians of their customers’ capital.  

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