This week, Devin is continuing the conversation about active versus passive investing with Rick Ferri, author of Smart Money. We ended last week’s episode talking about some of the arguments against passive management being made by the active management firms. This week is incredibly insightful and informative!
Devin asks Rick about the argument that indexing will lead to larger losses. The argument is that since this approach gets nearly all of the upside, they’ll also get nearly all of the downside. This implies that actively managed funds will avoid the down markets.
Rick explains that none of the academic data shows that the actively managed funds are able to get you out of the market before it goes down. When the market goes down 20%, active funds go down 21% or 22% because of fees.
Another argument is that because of the way that these market cap weighted, they are all buying yesterday’s winners. Does this differ from active management, and does that mean danger for the investors? Rick points out that this is true for all investments, active or passive. The whole point of this passive investing is from getting away from the emotions of investing and trying to figure out when is the best time to buy and sell.
Then Devin and Rick talk about how it affects the holders of actively managed funds when other people get out of the fund? One thing is that it depends on whether it is a taxable account or a non-taxable account. It can be really hard for actively managed funds as people leave because of the tax consequences.
Rick asks, what are financial advisors trying to do for their clients? Indexing has the highest probability of solving the investment portion of the question, so the financial planners are providing the best service by recommending index funds. What are some reasons why financial advisors wouldn’t recommend passive investing?
You can find more about Rick at RickFerri.com.
Right at the end, we learn about Devin’s added a new section to his SocialSecurityIntelligence.com website, featuring a forum where folks can sign up, post their question, and read the answers that are given to other people.
The important tax difference between ETFs and mutual funds.
Resources mentioned in this episode:
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