Burton Malkiel: Index Investing Beats Wasteful Active Management

http://www.newsmax.com/Finance/StreetTalk/Burton-Malkiel-active-passive-index-investing/2017/06/07/id/794680/

Burton Malkiel, an Princeton professor and author of the best-selling “A Random Walk Down Wall Street,” said new data add to the evidence that putting money into an index fund that tracks the stock market is better than investing in a mutual fund that picks stocks to buy and sell.

“During 2016, two-thirds of active managers of large-capitalization U.S. stocks underperformed the S&P 500 large-capital index,” Malkiel wrote in The Wall Street Journal, citing data from Standard & Poor’s. “Nor were managers any better in the supposedly less efficient small-capitalization universe. Over 85 percent of small-cap managers underperformed the S&P Small-Cap Index.”

 

Investors this year have continued to put more money into index funds than into actively managed funds. About $17 billion was deposited into equity passive funds in April, while investors pulled $16 billion out of active mutual funds,  according to data compiled by Morningstar. Last year, investors pulled $340 billion from actively managed funds and invested more than $500 billion in index funds. Index funds now account for about 35 percent of total equity fund investments

Active fund also charge higher management fees that cut into investor holdings.

 

“The index investor will achieve the market return with close to zero cost,” Malkiel said. “Actively managed funds charge management fees of about 1 percent a year.”

Malkiel's "Random Walk" book argued for the efficient-market thesis that prices quickly reflect all the known information about a security. Malkiel famously claimed that “a blindfolded monkey throwing darts at a newspaper's financial pages could select a portfolio that would do just as well as one carefully selected by experts.”

Malkiel this week also dismissed critics who say index investing is allocating capital to stocks that don’t have the earnings and sales growth to back their valuations. He cited a 2016 AB Bernstein report by analyst Inigo Fraser-Jenkins titled “The Silent Road to Serfdom: Why Passive Investment Is Worse than Marxism” as an example of a fallacious argument against index investing.

 

“What would happen if everyone began investing in index funds? The possibility exists that they could grow to such a size that they would distort the prices of individual stocks,” Malkiel said. “The paradox of index investing is that the stock market needs some active traders to make markets efficient and liquid. But the substantial management fees that active managers charge give them an incentive to perform this function.”

 

He said that active fund managers don’t need to worry about total extinction.

“Even if the proportion of active managers shrinks to a tiny percentage of the total, there will still be more than enough of them to make prices reflect information,” Malkiel said. “Americans have far too much active management today, not too little.”

He said mom-and-pop investors are the biggest beneficiaries of low-cost passive strategies.

“Index funds have been of enormous benefit for individual investors,” he said. “Competition has driven the cost of broad-based index funds nearly to zero. Individuals can now save for retirement far more efficiently than before by assembling a diversified portfolio of index funds. There is no better way to preserve and grow one’s savings.”