The Active v. Passive Investing Dichotomy

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The Controversy Continues


[By Amaury S. Cifuentes CFP® CMP®]

Physician and all investors are often overloaded with information regarding this debate, and many advisors differ in the conclusion of which strategy is best.

Stock Picking

Stock picking is typically a waist of time and few investors or advisors demonstrate the constant ability in picking winning stocks. Timing the market also becomes difficult and typically has negative effects in a portfolio. Investors will also find that they will usually have very little luck finding money mangers that can consistently out perform the market. Investors over a long period of investing time horizon would benefit from passive investing vs. active trading, with some exceptions.

Active Investors

Active investors spend time analyzing stocks or mutual funds based on a mismatch of the price relative to its value. In an efficient market, there is little or no mismatch between the current price and the true value of the investment. Also, real cost and expenses of active management are rarely calculated;  some consider the stock market a zero sum game, if the total market returns eleven percent then the investors must deduct the cost of the transaction, which would lower their return relative to the market.

Mutual Fund Performance

For example, Mark Carhart’s comprehensive study of 1,892 mutual funds title “On Persistence in Mutual Fund Performance” showed that on average mutual fund manager under performs by 1.8% to their relative index.  In addition, William Sharpe Nobel laureate article “The Arithmetic of Active Management” stated that after cost, the return of active management dollars would be less than passive dollars.

Market Timing

Timing of markets is also very difficult. Timing the market can be defined by moving your asset from risky to non risky assets before negative events happen. The Random Walk Theory basically states that there are no patterns in the stock market prices. Basically, information moves the markets and information is random, so logic would suggest that timing the markets effectively is futile. Many reports demonstrate this effect, for example, a report form Javier Estrada, a finance professor at IESE Business School in Barcelona, Spain. He studied the DJIA form 1900-2008 and concluded that if you subtracted the ten best days from the market two thirds of the cumulative gains would disappear (10/29694 or .03%), almost impossible to predict even by the most astute investors. Much more extensive research showing that market timing does not work, Wei Jiang paper “A Nonparametric Test of Market Timing” concluded that timing ability on average is negative. There are countless of studies showing that there is no evidence that timing the markets can produce superior returns.


Investing Difficulties Continue

To make thing even more difficult, investors that seek profession help cannot guarantee that the active managers they hire can consistently over long period of time outperform their benchmarks.  Obviously, it is evident that past performance is no indication of future results as advertised by all financial institution, and most active managers who outperform their bench market do not do consistently over long periods of time. John Boggle’s comprehensive study in 1992 of the Forbes Honor Roll title “Selecting Equity Mutual Funds” concluded that after commissions loads were taken into account the honor roll under performed the market between 1974 and 1990 by a difference of 193.75% cumulative.

Of Professor Burton Malkiel

Furthermore, investors over long periods of time will find that stock picking, timing the market and selecting active managers do not produce superior returns. John Stossel of ABC’s 20/20 interview Professor Burton Malkiel of Princeton University and stated in the interview that “All the information an analyst can learn about a company, from balance sheets to marketing material, is already built into the stock price, because all of the other thousands of analysts have the same information. What they don’t have is the knowledge that will move the stock, knowledge such as a news event, which is unpredictable and impossible to forecast.”


Physicians and all investors may be better off concentrating on asset allocation, picking low cost investment, deciding on tactical or strategic rebalancing and implementing models like the three factor model as pioneered by Professor Eugene Fama and Professor Kenneth French in lieu active management.


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9 Responses

  1. Amaury,

    Aren’t we gilding the lily with all this theoretical nonsense here; and on TV, with podcasts, webcasts, internet, cable news and elsewhere?

    I mean, didn’t we just learn that Federal regulators finally charged Florida and Texas based financial advisor and financier R. Allen Stanford and three of his companies with a “massive” fraud that centered on high-interest-rate certificate of deposits [CDs].

    Way to go SEC, er-ah FINRA, er-ah; nobody!
    The dominos are just starting to fall; watch out.

    The Wise Guy


  2. Seeking Charles Ponzi

    It has been alleged that the FBI is currently investigating about 500 alleged Ponzi schemes. But, will we rival the mega-frauds of Bernie Madoff and Allen Stanford?

    And, it was recently disclosed that at the National Democratic Convention, in Denver last year, House Speaker Nancy Pelosi gave Stanford a warm public embrace, while attendee WJ “Bill” Clinton gave Stanford videographers public relations footage of a similar ilk.

    So, will the cumulative effect of these shenanigans be far-reaching? And, as the proliferation of scams seems so pervasive, is it only a matter of time before we all are affected by a Ponzi scheme?

    Think Kevin Bacon and the 6 degrees of separation.



  3. Amaury,

    Nice job with the above, but it seems very traditional to me and not at all new.

    Nevertheless, did you know that only about one-third of financial services executives expect their industry will recover ahead of the national economic rebound, although 78% of them expect business conditions to improve in their sector in 2010?

    Now, that is harsh news!



  4. For those “active management” aficionados, which criteria reliably predict those funds that will outperform in the future?

    Some turn to the Morningstar rating system. A recent article by Russel Kinnel, director of mutual fund research with Morningstar, points to Morningstar data that finds that expense ratios are a better predictor of fund performance than the star rating system.


    Brian J. Knabe MD CMP™



    “The best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.”
    -Warren Buffett

    Hope Hetico RN MHA
    [Managing Editor]


  6. Active Funds Continue to Lose Share

    According to Joseph Giannone, this report shows the continued ascendance of passive investment funds for core asset classes.

    Any thoughts?



  7. Active versus Passive Investing

    Mutual funds generally fall into one of two camps: On the one hand, there are actively managed portfolios that are run by stock pickers who attempt to beat the broad market through skill and strategy.

    Then there are passive funds, which are low-cost portfolios that simply mimic a market benchmark like the S&P 500 by owning all the stocks in that index.

    The question for individual investor is – which one to go with?


    Liked by 1 person

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