Indexing
IndexingActive and Passive Indexing
The first index fund began in 1971, with $6 million funded by Samsonite, the luggage-maker. Since then, there have been many arguments of whether an active index fund or a passive index fund offers better long-term results for investors.
Index funds are already the fastest growing sector of the mutual fund business. From 1986 to 1996, the amount of money invested in index funds grew from $556 million to $65 Billion. And if anything, individual investors have been slow to embrace passive management. Institutional investors invest a far larger percentage of their assets passively.
Many individual investors are simply uneducated and unaware of the arguments and experimental evidence supporting passive management. Institutional investors and academics have known for years (many for decades) that passive investing is extremely difficult to beat and that the majority of active investors will fail in their attempt to outperform the market.
Active indexers assert they can outperform the marketplace. Passive (index) portfolios state they can mirror the performance of the indices. Both have their good times and their bad times. Active indexers raise cash in times of increased risk and instability while passive indexers remain fully invested. This can be quite painful during times of large declines in the market.
Passive portfolios mirror the gains of the indices during roaring bull markets and eventually outperform the majority of active money managers who must remain diversified and who sometimes take on additional risks in an attempt to produce the performance and safety that they have promised their clients. The evidence has piled up during today's bull market that the average dollar managed by active managers does not keep up with the market index. Finally, indexing is a way to avoid being blind-sided in certain areas of the marketplace. Active management themes can easily find themselves on the wrong side of an investment. There is a perception among investors that a strategy designed to match stock market returns is less risky than a comparable actively managed portfolio. Since the index approach invests in a manner that is most friendly with the market's natural liquidity, it produces the least disturbance. The passive investor also has diversified his risk. Specific negative things can happen to individual companies or groups. As a passive investor, one is not exposed to any of these things. However, it does not mean you have a risk-free investment.
The downside to passive index investors is that they "fuel the fire" of a market that appreciates well beyond its true value. Index mutual funds must put new money to work...they can not hold cash...and their investors all buy the exact same stocks. When stocks go down, index funds, being fully invested, will receive the ultimate effect of the decline. Combined with this loss is the fact that they will also have to sell shares to cover shareholder redemptions. These funds will get hit harder than many active portfolios with a cash cushion. Most...
To view the complete essay, you be registered.