WHAT IS PASSIVE ASSET CLASS INVESTING?
Passive investment management makes no attempt to distinguish attractive from unattractive securities, or forecast securities prices, or time markets and market sectors. Passive managers invest in broad sectors of the market, called asset classes or indexes, and, like active investors, want to make a profit, but accept average market returns various asset classes produce. Passive investors make little or no use of the information active investors seek out. Instead, they allocate assets based upon empirical research delineating probable asset class risks and returns, diversify widely within and across asset classes, and maintain allocations long-term through periodic rebalancing of asset classes.
WHAT IS INDEX INVESTING?
Index investing is a form of passive asset class investing in which portfolios are based upon securities indexes which sample varoius market sectors. Best known are the Dow Jones Industrial index and the Standard & Poors 500 index. Indexes are available for most domestic and international markets, and rise and fall as individual securities within the indexes rise and fall.
WHICH WORKS BEST, PASSIVE OR ACTIVE?
Research supporting passive asset class investing comes from the nation’s universities and privately funded research centers, not from Wall Street firms, powerful banks, insurance companies, active managers, and other groups with a vested interest in the hugh profits available from active management. The results from this research are very clear: Active investment is an appealing mirage which substantially boosts costs and decreases returns compared to properly designed passive asset class portfolios. Research employed in the development of passive asset class and index investment strategies has shown that:
• Markets and economies are unpredictable
• Future securities prices are unpredictable
• Risk and return are absolutely correlated
• Active management is more expensive
• Active management is more risky
• Active management underperforms passive management
• Exceptional active managers cannot be identified in advance
• Asset Allocation is the most important determinant of investment returns
• The “Smart” money uses passive investment strategies