In the world of investing, there are two camps. The two camps co-exist – and some people hang out in both – but for the most part, each camp generally thinks the other is doing something wrong.
The industry calls the two camps Active and Passive. But I think it’s easier if we label them the Do-Better camp and the Do-No-Worse camp.
All investors choose a camp, whether they know it or not. And which camp you choose can have a significant impact on your experience as an investor.
The Do-Better camp is hell-bent on trying to beat the market. The “market” can be defined in a lot of different ways: big companies in the U.S., small companies outside of the U.S., and so on. But whatever market the Do-Better camp selects as its benchmark, they aim to outperform it.
That sounds wonderful. Who wouldn’t want market-beating investment returns?
The Do-Better camp hires smart people and pays them big bucks to select investments in their defined market that have attractive prospects and to avoid investments in that same market they suspect will perform poorly. Those in the Do-Better camp are constantly reevaluating their investments and have a greater tendency to buy and sell investments at a faster clip.
If successful, the Do-Better camp is likely to attract more investors, which means more money to invest and higher profits. If they are unsuccessful, however, their investors would have been better off investing in the market itself and not paying relatively high fees to the Do-Better camp.
The Do-No-Worse camp takes a different approach.
Its proponents believe that most markets are nearly impossible to beat, especially over long periods of time. So rather than try to outperform the market, the Do-No-Worse camp attempts to match the market. They don’t try to pick the best investments in the market or to avoid the likely losers. The Do-No-Worse camp just buys all the investments in the selected market and holds them.
By doing so, they assure their investors they will do no worse than the market.
If the market goes up, investors in the Do-No-Worse camp will do well. If the market goes down, they will feel the pain. Over time, the performance of the Do-No-Worse camp will essentially reflect the performance of the market itself, minus a tiny fee for their efforts.
Each camp has one big question for investors trying to decide which camp to choose.
The Do-Better camp asks, “Why would you simply want to match the market when we hold out the prospect of outperforming it through our superior investing skills?”
The Do-No-Worse camp questions, “Why would you take the risk of trying to beat the market, and ending up in a worse place if you are unsuccessful, when most markets perform well over time?”
Fortunately for us, the industry has been tracking the performance of both camps for decades.
Let’s focus on one particular market, the S&P 500. This is the 800-pound gorilla of stock markets. It’s simply a collection of 500 of the largest publicly traded U.S. companies.
Over the last five years ending Dec. 31, 2020, only about 25% of the Do-Betters – in other words, Active investment funds – that have selected the S&P 500 as their benchmark have actually outperformed the S&P 500. The other 75% raked in fees but left their investors worse off.
If we widen our lens and look at the last 10 years, it gets worse. Only 18% of the Do-Betters have outpaced the S&P 500. And if we look back 20 years, just 6% have surpassed the performance of the market.
What’s this mean? To put it bluntly, choosing the Do-Better camp is a little like gambling at a casino. The longer you play, the more likely you are to lose.
That’s a big reason why I sit squarely in the Do-No-Worse camp – otherwise known as Passive. Most markets will do well over time. Just hitch a ride and hang on.
Passive beats Active the majority of the time. So, if you can beat them, why join them?