Let's look at the percentage split between active and passive fund management. Conventional wisdom says that active fund management has a hard time outperforming passive fund management over the long term. Therefore, one would expect a growing percentage of passive funds overall.
According to Bank of America Merrill Lynch, passively managed funds has risen to 45 percent of all funds in 2020, up from 44% in 2019. The rise in passive management has seen a consistent increase since the financial crisis in 2009 according to data from Morningstar, the largest fund rater.
Passively managed funds are funds that track a particular benchmark, like the S&P 500. Passive funds include ETFs like SPY and index funds like VTSAX.
It is pretty clear that the trend towards a greater percentage of passively run funds versus actively run funds will continue in the foreseeable future.
Active And Passive Split: Active Fund Management In Decline
In 2009, active management had a nearly 3 to 1 advantage over passive manage in U.S. equity funds, according to Morningstar. Now the two are almost at parity.
Actively managed funds, on the other hand, are funds run by portfolio managers who often have a team of analysts picking individual stocks to try and beat their respective benchmarks. Examples include the Fidelity Contrafund.
Active management has consistently declined as a percentage of total types of funds largely due to high fees and the majority of the actively managed funds underperforming their respective benchmarks.
Below is a chart highlighting that the majority of Institutional Managers underperformed their respective benchmarks over 10 years from 2008 through 2018.
Most Active Institutional Managers Underperform
Below is a chart that highlights the majority of Mutual Funds available for retail investors have also underperformed over 10 years between 2008 – 2018. In fact, Mutual Funds have performed even worse in almost every category compared to Institutional Managers. The data shows the recommended active and passive split should lean more passive.
The Downside To Passive Investing
Recently, more and more people are saying passive investing is in a bubble. But the criticism largely comes from active fund managers and active investors who are ignoring the underperformance data and trying to protect their old ways.
Critics of index funds say they are too susceptible to the changes in a few market-moving stocks, virtually guaranteeing that investors won’t generate alpha, while also potentially posing liquidity risks in times of market stress.
The reality is that to build wealth, you must control what you can control. Every investor should keep their investing fees to a minimum, save and invest consistently and aggressively, while properly allocating capital in a risk-appropriate manner.
Paying higher fees for funds that underperform over the long-run makes no sense. Therefore, investors should allocate the majority of their stock and bond investments to passive funds. Whether the allocation is 51% – 100%, it's up to each investor to decide.
Bond Funds Are Also Going More Passive
Passive index investing has also gained popularity in all categories of fixed income investment as well. When thinking about the active and passive split for bonds, the thought process is similar with equities.
Passive funds now have 25.3 percent of the market in total bond funds. This is also up a full percentage point from June 209. High-grade index funds now have a 29.9 percent share, compared to 29.7 percent, while high-yield has increased to 13 percent from 12.9 percent.
Below is a chart showing that the majority of actively run Institutional Bond managers also underperform their respective benchmarks over a 10-year period between 2008-2018.
Below is a chart highlighting the percentage of Fixed Income Mutual Fund managers underperforming most of their benchmarks over a 10-year period as well. Although if you want to invest in an actively run fixed income fund, it's a good idea to choose the best Investment-Grade short Funds, Global Income Funds, General Municipal Debt Funds, and California Municipal Debt Funds. Most of these actively run fixed income funds have outperformed their respective benchmarks.
Active And Passive Split: Best To Invest Mostly Passively
Despite the conclusive data that investing in passive funds is better for your financial health than investing in active funds, some people will still be smitten by good marketing, a strong brand, and an attractive pedigree of the portfolio manager. That's fine. Just know in the long-run, outperforming a benchmark is highly unlikely.
Here is my recommended split between passive and active investing. The largest percentage allocation you should have towards active investing is 50%. The active and passive split will ultimately be up to you.
If you still love the idea of actively run funds, know that there is a level of active involvement in deciding what goes into a particular benchmark and its weighting. For example, variables such as market capitalization, profitability, float and liquidity, and geographic revenue composition play a factor in determining the S&P 500 index composition.
Minimize Investment Portfolio Fees
The active and passive split will always be a big debate. However, the main thing you can actively do is analyze your investment portfolio for excessive fees. Then replace those high-fee funds with low-fee funds. To do so, I use Personal Capital's free Investment Analyzer tool. Sign up, link your investment portfolios, and have Personal Capital analyze where you could be saving.
Below are the results of my 401(k) fees. I had no idea I was paying $1,748.34 a year in fees. Those fees would grow to over $85,000 in fees in 20 years. As a result, I sold old my actively run funds and replaced them with low-cost ETFs.
Not only can you analyze your investment portfolios with Personal Capital, you can also track your net worth. You can also run some great simulations with your retirement funds through their Retirement Planner.
There is no rewind button in life. Make sure you end up with a little too much money than with too little. The last thing you want to do after you retire is go back to work!
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