Last week we presented some of the downsides to the craze gripping the market: passive investing. This week, we put forward the case for the defence.
In case you missed it, passive investing — such as pouring into index funds and ETFs have proven popular over the past few years.
It’s estimated that up to 47 percent of all assets on the market are held in such funds.
There’s generally some pretty good reasons behind the growth of passive investing in recent years — here are six of them.
As always, content on Star Investing is not an investment recommendation.
6 reasons why passive investing can be a good thing
1. Fewer fees
One of the main gripes active investors have is that a lot of their returns can be taken up by fees paid to active asset managers.
It’s galling to see your portfolio generate a return, only for management fees to erode that return.
There is a reason that the returns (by and large) are better with actively managed industry superannuation funds than pure retail funds and this is reflected in the time spent managing investments.
Those management fees aren’t the result of pure greed but rather a function of the fact that more time is invested in managing an active portfolio as managers try to create value on a more frequent basis.
A manager, or even a robot, can engage in more ‘set-and-forget’ management as they’re set up to track an index — so naturally that comes with less management.
What’s more, in the battle between active managers and robots — the robots are winning.
2. Not all active managers deliver a return
Just because you pay a higher fee for an active manager it doesn’t mean you are guaranteed a return on your investment.
You’ve probably heard the old one about the monkey with a dartboard being a better fund manager than Harvard-educated managers.
You’ve probably also heard about Warren Buffet’s famous bet.
These are fairly extreme examples, and they have a few caveats attached to them — but the sentiment holds true: a lot of active managers don’t deliver returns above the broader market.
For example, S&P Dow Jones Indices provided figures to the Australian Financial Review indicating that 57.6 percent of general Australian shares funds underperformed against the broader ASX200 in 2017-18 [$].
It means you have a more than even shot of getting a better return with a fund set up to track the ASX200 than you do if you give your money to an active manager.
3. No hassles, man
If you’re the type who doesn’t like checking on their investment the way people check Facebook, then active management can be a hassle coupled with a burden.
Passive investment options, oddly enough, are tailored to people who like to set-and-forget with their investments.
Whilst active investing can have a greater scope for gains above the market trend the opposite can also be true.
With no guarantees of a better return with an active manager and higher fees it’s no wonder the set-and-forget strategy is appealing.
4. The buy-in is often lower, making it easier for smaller investors
Active trading usually comes with a buy-in cost associated with it.
For example, with the ASX the minimum amount of initial stock in a particular company somebody can buy is $500. You can trade in smaller amounts after the initial investment, but while $500 may not seem like a lot it can be a lot for people first starting on their journey.
Buying into actively managed fund can be even more onerous.
For example, Bennelong’s silver rated Australian Equities Fund was the top returning fund in the Australian Equities Large Cap category for financial year 2018 for MorningStar – and the minimum investment for this fund is $10,000.
It’s why ETF or index-linked products like tech-focused Raiz, Spaceship and Robin Hood have found traction among younger investors, particularly millennials looking to get into the market for the first time.
Add in that passive investment vehicles generally have lower management fees than active ones and a lower risk profile, and there’s a good reason why passive investing can appeal to those just getting started.
5. What goes up…
One of the very valid points made by active managers is that if you’re set up to track the market, you sure as heck can’t beat it.
Active managers can gain an advantage over passive managers by selling on a share’s upswing, generating a return above the market — and it’s for this reason why a volatile market can be an active trader’s best friend.
But, a volatile market can also expose investors to sharp downward movements as well — and given active managers can look at more volatile stocks to generate more opportunities for a return, those who don’t like risk may not want to get into active trading.
6. Rewards longer-term shareholders (on average)
Passive investing can reward those who are in the game for the long term, notably through a dollar-cost averaging strategy.
Because there’s greater certainty on the return with a passive strategy rather than an active one, it makes it easier to generate a better return in the longer-run.
If you’re looking to make a return in a short time frame an active strategy may suit better, but for longer-term holders who are happy to set-and-forget a passive strategy likely has more appeal.
This content does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.
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