Professor Charles D. Ellis of the Rebalance Investment Committee active trading works against us. More on the dangers of active trading.
First of all, active is a great word. Everybody would like to be active. Passive is a terrible word. Nobody wants to be passive. Analogies … would you like to be a passive spouse? Would you like to be a passive parent? Would you like to be a passive employee? Nobody wants to be passive. So it’s got a bad name.
If you said indexing or index matching, probably getting closer to what people would normally feel, without any emotional tonality to it, was more sensible. Active investing, typically, you are seeing turnover in the portfolio of 100%, 110%, 120%, 130% every year.
Now take a typical portfolio of 80 stocks and 100% turnover, which would be in the low end of the spectrum, that’s 80 different major investment decisions every year, two a week, roughly.
Say wait a minute, that’s to actually buy. How many would you make decisions not to buy? Well, probably two or three times as many. So you’re boiling down to every day of your working career, you’re making a major investment decision. What are the chances that you’re going to make a really terrific investment decision against all those capable people who are setting the prices on the base of complicated information, trying to organize, to think about the future and how it might develop? What are the chances you’re going to be really right on a high frequency basis? Very hard.
Second thing is passive, or index investing as I like to call it, typical turnover is 5%. And what does that mean? It means less in the way of taxable gains. And a lot of tax imposed on active management because a lot of those trades are short-term profit makers. So, after-tax makes a big difference. And then look at the record. And the hard part is the record says that active managers, on average, underperform the market by about the magnitude of their fees.