Tahoe Market Pulse: Active vs. passive? The debate is over
Forty years ago Vanguard created the first index fund that tracked the S&P 500. At the time, many thought it was a crazy idea to just own an index instead of having a manager select attractive stocks or do it yourself. The S&P 500 index fund has since become the largest mutual fund.
For some time there was a debate of whether to own index funds or actively managed funds. That debate is over. Thanks to their low fees, index funds have outperformed most of their actively managed peers and 8 of the 10 largest mutual funds simply track an index. Index funds are winning the battle over hedge funds, too, as the latter are shuttering at a staggering rate.
While baby-boomers still like mutual funds, exchange-traded funds (ETFs) are gathering assets faster. Most every ETF is passively managed to make indexing even more popular. ETFs are especially popular with millennials. A study from Charles Schwab shows that millennials are putting 36 percent of their investments into ETFs and plan to boost their ETF holdings over the next year.
Of course, just because you own passively managed ETFs doesn’t make you a passive investor. ETFs provide the flexibility to easily invest in specific areas of the market. Momentum investors can buy the strongest areas, currently Emerging Markets (EEM), Networking (IGN), and Coal (KOL).
Bottom-fishers can buy areas that have recently emerged from their own bear markets, such as Energy (XLE), Greece (GREK), and Italy (EWI). And the extremely liquid S&P 500 SPDR (SPY) allows traders to easily jump into and out of the market. Of course, that game is easier said than done, especially during the last seven years.
One active indexing approach that I use is to rotate to the strongest broad market segments, as opposed to simply holding the S&P 500. This year, small-cap stocks have outperformed so I’d rather own an ETF that tracks a small-cap index like the Russell 2000.
By holding a combination of individual stocks (no cost of ownership) along with some low-cost index funds, an investor can build an attractive portfolio that overweights specific securities while avoiding areas that are less attractive. And this can be done while paying very little in fees. That is to our advantage.
David Vomund is an Incline Village-based fee-only money manager. Information is found at http://www.VomundInvestments.com or by calling 775-832-8555. Clients hold the positions mentioned in this article. Past performance does not guarantee future results. Consult your financial adviser before purchasing any security.