On Monday, The Wall Street Journal reported that investors are giving up on beating the stock market…
Investors of all stripes are flooding into passive investment funds that merely track an index instead of actively trying to outperform it.
From the Journal:
“Over the three years ended Aug. 31, investors added nearly $1.3 trillion to passive mutual funds and their brethren—passive exchange-traded funds—while draining more than a quarter trillion from active funds, according to Morningstar Inc.”
That’s a massive shift in assets. And it’s happened because investors have been conditioned for years to believe the efficient market theory that says they can’t trump the stock market, so why even try.
But what if that’s all just one big lie?
Look, I get why people are fleeing active funds…
Morningstar reports that between 71% and 93% of active U.S. stock mutual funds have underperformed the index funds they tried to beat over the past decade.
Why pay billions in fees to incompetent fund managers who can’t even outperform the market?
That’s the simple pitch Vanguard and many others have used.
They preach that the stock market is already efficient. So investors have little to gain from active management strategies that profit from inefficiencies. Active investing just reduces returns due to management fees and transaction costs.
That pitch has worked wonders. Investors are turning in droves to passive funds, which make no attempt to beat the market.
But that approach has two fatal flaws…
First, passive index investing will keep you fully invested during destructive bear markets like the one in 2008.
Many people don’t realize that a 50% drawdown requires a 100% return just to get back to even. One mistake like that during your lifetime and you’re ruined forever.
And the market has historically suffered a downturn of at least 50% every ten years or so.
Are you going to stick with passive investing knowing that? You’ve given up if you do.
Second, contrary to what Vanguard would have you believe, it’s relatively easy to outperform the stock market.
Tobias Moskowitz, from the University of Chicago, did an exhaustive analysis to see if anyone could do so simply by following the trend. Here’s what he concluded:
“Α diversified portfolio of [trend following] strategies across all asset classes delivers substantial abnormal returns.”
Translation: Trend following outperforms the stock market big time.
Plus, an in-depth study by ΑQR Capital Management revealed that trend following has outperformed traditional portfolios in all past market crashes dating back to 1903.
The bottom line is trend followers have been beating the market for a long, long time. And they’ve been doing it without the disastrous drawdowns that come with passive index investing.
So don’t fall for the spin that passive index investing is your only alternative to the failed active fund model.
Trend following’s outsized historic performance reveals there’s a far superior option staring right at you.
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This story originally appeared in the Daily Reckoning