The Word From Wall Street: Be Passive, Make Money
WHY YOU SHOULD CARE
Sometimes being aggressive is the last thing you want to do with your investing dollars.
Like father, like son — at least that’s how Joe Mercurio approached investing. The retired Walgreen exec says he used to be a pretty type A investor, picking his own stocks and actively managed funds. And to hear the 67-year-old talk, he was pretty damn good at it, along with some famous names in the actively managed funds business he used, including the legendary Max Heine. “I loved that guy,” says Mercurio, who lives in eastern Michigan.
So why has he changed his tune and started using a financial adviser of a different breed? The goal now doesn’t have quite as much chest-thumping: Instead of trying to beat the market, the object is to stay even with it, at least. “I’ve started to get nervous in the past year,” says Mercurio. “I don’t want to make a big mistake.”
Mercurio’s tactics might sound kind of boring, but it also happens to be the way of the world of investing as of late — and may be for some time, even if the recent market gyrations continue. Indeed, investors young and old who dabbled with both so-called “active” and “passive” investing appear to have made a decision. Never mind what some big financial firms are selling — steady is the way to go. Look at the data, and the trend is kind of startling: In the first half of the year, $2.7 billion trickled into actively managed mutual funds. Passive funds? They got $118.1 billion, according to Morningstar, which provides industry data. That’s over 40 times more.
There’s obviously a lot on the line for investors these days when it comes to the active vs. passive debate.
Certainly, some active funds, which are run by folks who select specific stocks or bonds to buy rather than use a passive strategy, where they just grab financial products listed in an index, can still be worth it. That’s one reason a big-name financial firm like Fidelity has already launched a high-profile ad campaign to convince investors that active management is worth paying for. But is it? Investors like Mercurio are joining millions of others who’ve chosen a passive approach that’s been backed by academic theory, recommended by many financial advisers and performed pretty well since the 2008 market crash. (“There’s certainly a spot for passive management,” though active funds can also be strong performers, says Darby Nielson, managing director of quantitative research at Fidelity.)
Does any of this matter to the little guy? Actually, it does. If you had $10,000 and it grew over a decade, just a single point higher return — say, 8 percent rather than 7 percent — would produce an extra $2,300 or so. Wait 30 years and that amount balloons to over $100,000 versus around $76,000, thanks to that 1 percent difference. When it comes to the active vs. passive debate, generally speaking, passive funds tend to do better when the market rises, while active ones seem to improve when it falls, says Tim Clift, chief investment strategist at Envestnet, an investment service provider.
Historically, the stock market’s had many years when active managers have done relatively well, such as in the early ’90s, and again after the dot-com market crash of 2000. According to research from Fidelity, active managers of small company and international funds beat their goals (they call ’em “benchmarks”) from 1992 to 2014. With the backing of the company behind these funds, Fidelity saw an inflow of at least $2 billion into its active funds in the first four months of the year, says Katie Reichart, an analyst at Morningstar. Even Vanguard — a well-known champion of passive index investing — is embracing active managers and offers its own stable of actively managed funds.
Yet most investors are going the other way now, wary of active funds. Doing research to pick stocks or bonds costs money, so fees for active funds are usually higher than those for passive funds. Because information about companies is so quickly shared in the market these days, it’s hard for a money manager to add enough value to warrant extra costs, says Nobel Prize-winning economist Eugene Fama, who teaches at the University of Chicago. What’s more, good performance one year isn’t a strong predictor of superior performance the next year. And for many savers, the “average” return provided by passive index funds is pretty good, if they stay the course — but most of them don’t, according to market research firm Dalbar.
Still, the post-2008 run for passive investments has been extraordinary, and has left both stock and bond prices at historic highs earlier this year. Which, of course, now makes many investors increasingly nervous about future returns. But that’s where patience might just be the most important ingredient for any investor’s success going forward.