Passive investing reaps richer rewards

Most mutual funds are run by people picking stocks or other investments that they think will earn above-average returns. Index funds, however, are passively managed. That is, they seek only to match (rather than beat) the performance of a given index. The goal of most actively managed funds is to earn a return greater than that of their respective indexes. Interestingly, most investors actually would be better off in index funds. Why? Due to the high costs of active management, the majority of actively managed funds fail to outperform their respective indexes.

Picking funds based on superior past performance was usually unsuccessful and proved to be only slightly better than picking randomly. If you’re looking to pick a future top performer, picking a low-cost fund is your best bet. And looking for low-cost funds naturally leads to the selection of index funds as likely top-performers.

Why Index Funds Win:  Because all the fund has to do is buy all of the stocks (or other investments) that are included in the index. When you compare such a strategy to the strategies followed by actively managed funds (which generally require an assortment of ongoing research and analysis, in order to try to buy and sell the right investments at the right times) index funds tend to have considerably lower costs than actively managed funds. It’s counterintuitive to think that by not attempting to outperform the market, an investor can actually come out above average.

A strategy for picking funds would be as follows:

1. Determine your ideal overall asset allocation (that is, how much of your overall portfolio you want invested in Indian stocks, how much in international stocks, and how much in bonds).
2. Determine which of your fund options could be used for each piece of your asset allocation.
3. Among those funds, choose the ones with the lowest expense ratios and the lowest portfolio turnover.

Source: Oblivious Investor

AM Comments-

• Passive investing is polar opposite of active investing, which is a more aggressive strategy offering possibility of larger short-term gains, but also accompanied by higher risk and volatility.
• Passive investing may be laissez-faire. It’s a well-thought, long standing philosophy which believes that even though the stock market does experience ups and downs, it inevitably rises over the long periods.
• The concept underlying passive investing is that the longer-term outlook on markets is bullish, which will result in financial gains along the course. As a result, it is better suited to investors with a longer time horizon, such as retirement planning.
• One of the primary reasons for the success of passive funds is their low cost. Fees for index funds in India are normally in the range of 0.1-0.2 percent of AUM, while fees for actively managed funds can range from 1-1.5 percent of AUM.

Passive investing is gaining traction in India as a result of greater mutual fund penetration and accessibility, which is no longer a barrier thanks to the availability of various online platforms.