In many, if not most, aspects of your life, you'll do better being active than passive. Lead an active lifestyle instead of being sedentary, and you may live longer, with fewer health complications. Have an active social life, and you may keep loneliness at bay and perhaps meet a soulmate sooner. Raise your hand often at work, and you may get ahead effectively.
You can choose to be active or passive when it comes to investing and financial matters, too. You might manage your money passively, for example, by automating some transactions -- such as automatically paying some bills and contributing to retirement accounts. Here's a look at active vs. passive investing. See which approach is best for you -- and which is, in many ways, best overall.
Image source: Getty Images.
Active vs. passive, explained
Active and passive investing are two key investing approaches. You'll see the two in the world of mutual funds, as an example. Actively managed mutual funds are ones where financial professionals study the universe of investments and decide which ones to buy and sell, and when to do so. Passively managed mutual funds are ones where the investments are prescribed and require little decision-making.
Think of a classic index fund, such as one that tracks the S&P 500 index. It will invest in the 500 companies that make up the index -- in roughly the same proportion. The fund's managers simply have to follow the relevant index. When the people who manage the S&P 500 index decide to add and/or remove some companies, as they do now and then, index funds tracking the S&P 500 will soon be buying and/or selling those stocks.
And the winning strategy is...
The more effective way to invest in stocks is, arguably, to do so passively. Consider this: fully 95% of all large-cap stock mutual funds underperformed the S&P 500 index over the 20 years through 2022, per data from S&P Global. The S&P 500 reflects large-cap stocks, though. How about small-cap stocks? Well, 94% of all small-cap stock mutual funds underperformed the S&P Small-Cap 600 index over the 20 years through 2022. Real estate funds? 87% of all real-estate mutual funds underperformed the S&P United States REIT index over the 20 years through 2022. Indeed -- 92% of all domestic stock funds underperformed the benchmark S&P Composite 1500 index.
What about over shorter periods? Well, over the past 10 years ending in 2022, those indexes won out 93%, 94%, 74%, and 93% of the time, respectively.
Many smart investors recommend -- and invest in -- low-fee, broad-market index funds. Warren Buffett, for example, has directed that when he dies, much of his wealth be invested in an S&P 500 index fund. (He even bet a million dollars on index funds -- and won!)
Morgan Housel, a former Motley Fool contributor and author of the highly regarded book The Psychology of Money, favors index funds for most of his money, too. He has said, "Effectively all of our net worth is a house, a checking account, and some Vanguard index funds."
How to invest effectively -- and passively
So how might you invest passively? You might just regularly plow meaningful sums into one or more great index funds, such as the following broad-market ones that exist in ETF (exchange-traded fund) form:
- SPDR S&P 500 ETF (NYSEMKT: SPY)
- Vanguard Total Stock Market ETF (NYSEMKT: VTI)
- Vanguard Total World Stock ETF (NYSEMKT: VT)
The S&P 500 has averaged annual returns of around 10% over many decades. Here's how your wealth can grow if you happen to average annual growth of 8%:
|
Growing at 8% For: |
$7,500 Invested Annually |
$15,000 Invested Annually |
|---|---|---|
|
5 years |
$47,519 |
$95,039 |
|
10 years |
$117,341 |
$234,682 |
|
15 years |
$219,932 |
$439,864 |
|
20 years |
$370,672 |
$741,344 |
|
25 years |
$592,158 |
$1,184,316 |
|
30 years |
$917,594 |
$1,835,188 |
|
35 years |
$1,395,766 |
$2,791,532 |
|
40 years |
$2,098,358 |
$4,196,716 |
Data source: author.
Want to aim for more?
If you want to be a more active investor than that, and aim for even higher returns, you might engage in both active and passive investing. Devote a significant portion of your money to index funds, and the rest to carefully selected individual stocks -- or whatever you believe in most.
You might favor growth stocks, for example. They're tied to companies growing at a faster-than-average rate. You'll find lots of companies among them that have delivered or will deliver phenomenal returns, but that's far from guaranteed. So it's smart to spread your dollars across a bunch of them. Our Foolish investing philosophy suggests buying into around 25 or more companies and aiming to hang on to your shares for at least five years.
Just remember, though, that you can do phenomenally well simply investing in low-fee index funds over many years.
