Why passive investing over active investing?

I read about bet warren buffet placed in 2007 against active investors and that he won. But I dont understand how? I understand that in case of hedge funds as they charge so much fees but in case of mutual funds he’d be proved wrong. I analysed returns from hdfc amc funds and almost all of them beat the benchmark indices over 3-5 years. Some funds are not able to perform well but one just need to find the right fund…Also I dont understnd why american fund managers are consistenty underperforming the indices?

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Because an “An index is always designed to go up”. The entire world tracks and benchmarks performance against Index of their country.

Obviously no index will be designed to go down. Btw, benchmark indices are supposed to reflect the economy and industrial health of the country. Portfolios of fund managers are actually designed to increase in value always.

Thinking index is designed to go up is like thinking real estate investment is always gonna lead to profits

Dude, if you don’t know something, don’t say something random.

I very well know what I’m saying. I don’t need your assurance or approval. You might chose to disagree with me, but the least you could do is be courteous.



No they don’t.

There are a lot of perspectives to this passive vs active debate. I’ll try to briefly answer this to the best of my knowledge

The core idea behind passive investing is that markets price most of the information at any given point of time. John Bogle, the father of Index and founder of Vanguard investing puts this succinctly

The markets are highly efficient — although, importantly, not perfectly efficient. Sometimes they’re very efficient and sometimes they’re not. It’s hard for we poor souls on Earth to know which is which

This doesn’t mean that no one can outperform the market, but the number of people who can is very less. This put in real-world context means that you don’t know in advance who can beat the market. When you are investing in a mutual fund, you are essentially betting that the fund manager can beat the market and you have no way of knowing in advance whether he will be able to.

Now, you can either bet on the fund manager or follow the passive investing belief, that the market is supreme and invest in an index fund.

The advantage of an index fund is it offers a lot of benefits

  1. Total or extensive diversification
  2. Takes away individual stocks risk
  3. No emotions involved and hence no bias
  4. No fund manager risk
  5. Wide exposure major sectors and hence the chance to exploit growth across
  6. Most importantly low costs. I cannot stress this enough


Of course, the disadvantage is that you will be missing out on the chances of outperformance, but if you analyse funds, Indian ot otherwise, the alpha they are generating is consistently decreasing. Here are some data points
In the United States

As you can see that very few funds were able to beat their benchmarks.

Also, as markets develop the information asymmetry also decreases. This means that every fund manager will be privy to the same information and this edge will just fade away.

Check the return against the Total Returns and Index and you will see the outperformance if any reduces if not any altogether. Also, in India, our genius fund managers were all these years measuring performance vs the Index and not the total returns index. If you aren’t aware of the difference would suggest you read this post where Karthik has explained it beautifully. If you measure the returns vs the TRI index the resulting alpha substantially reduces and in case of some funds disappears altogether.

The question you should ask yourself is, should I pay a fund manager 2 to 2.5% just to deliver index-like returns when you could have achieved the same returns by investing in an index fund at a fraction of the cost (0.15% to 0.50%)

The second thing, is most fund managers in India are closet indexers or benchmark huggers. top 5 holdings of 53%. It also has one of the highest index weights in Nifty 50.

Quoting from the SPIVA report

Indian Large-Cap Equity Funds: Over the 1-, 3-, 5-, and 10-year periods ending in June 2017,
52.87%, 34.19%, 50.93%, and 58.47% of large-cap equity funds in India underperformed the S&P
BSE 100, respectively. Over the 10-year period studied, survivorship rate and style consistency
were low, at 66.1% and 28.81%, respectively. Over the same horizon, the asset-weighted fund
return was 79 bps higher than the equal-weighted fund return, and the return spread between the first and the third quartile break points of the fund performance was 3.11%.

Well, it’s easier said than done. Did you know that the funds you analyzed would beat the index 5 years ago? If yes, then please manage my money :slight_smile:

One of the most prevalent biases in the market is the overconfidence bias, the belief that we know better and can hence perform better. Nothing could be farher from the truth.

It’s simple. Beating the market is hard and costly.

If you want to learn more about pasive investing and indexing.

  1. This episode of Freakonomics podcast is highly recommended - The Stupidest Thing You Can Do With Your Money.
  2. The case for low-cost index-fund investing - report by Vanguard
  3. Setting the record straight: Truths about indexing report by Vanguard

There are two more pros of MFs:-

  1. lesser volatile than ETFs
  2. Fund managers can hedge through derivatives so limits losses in crisis situations and black swan events like recession, war etc.

passive investing has a lower expense ratio compared to managed where there is an annual cost of approximately 1-3% as part of my portfolio in additional to physical stocks i opted in the vanguard s&p500 e.t.f.

@Bhuvan what would happen, if everyone (or majority) starts investing in passive index funds? How will it change the market dynamics? Just curious to know. :smiley:

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A very interesting hypothetical question. This is a very fraught debate. Sanford C. Bernstein & Co called index funds “worse than Marxism”.

I just answered your other question.
A Blackrock report put the share of indexing globally at less than 20%. Moody’s forecasted the share of Index investing to exceed 50% by

A lot of crap being peddled about this topic, I’m guessing because of the SEO value. But Jack Bogle, the man himself says this is unlikely.

If a vast majority of the investing is passive then there can be mispricing in the markets. Because passive investors are terms as “price takers”. That is because they just buy everything without any consideration. Active managers can take advantage of this, which means higher returns, which means active inflows. Or at least that’s the theory. But yeah, these are uncharted waters. But as long as greed prevails, active managers will always find business. But the question of the costs, thats a whole new argument.

Jack Bogle said

“If everybody indexed, the only word you could use is chaos, catastrophe,” There would be no trading, there would be no way to convert a stream of income into a pile of capital or a pile of capital into a stream of income. The markets would fail.” But he also said the chances of that happening are “zero.”.

I’d recommend these reads and the podcast, if you want more perspectives.

Thanks @Bhuvan, just read another article:-

Attaching an article and picture for reference when I said an index is always designed to go up.