The Hidden Advantage of Professional Stock Pickers

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THE STASH NOVEMBER 2, 2009

The Hidden Advantage of Professional Stock Pickers

It's a truism that the average investor (i.e. one who doesn't get paid to pick stocks) is better off putting his money into a passive index fund than paying a pro to choose stocks for him. Once you factor in the extra fees actively managed investment vehicles charge, actual returns wind up being lower than what an index would provide -- and reinforces the notion that it's really hard to beat the market.

But Alex Savov, a doctoral student at Booth, the University of Chicago's business school, provides an interesting new take: He argues that active and passive investing actually turn out to provide the same returns. And the reason isn't because active managers are better than we'd previously given them credit for; it's that average joe investors have a terrible go at timing markets.

The following chart from Savov shows that money movements into and out of index funds are quite cyclical--passive investors tend to buy high and sell low--while flows for actively managed funds are more stable. (The chart shows the share of total stocks held in index (blue) and active (red) funds.)

When you factor retail investors' horrible timing and active funds' (relatively) good timing, the buy-and-hold advantage of index funds seems to disappear:

"The broader message is that performance evaluation should consider the end returns earned by investors and not simply buy-and-hold returns."

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posted in: the stash, economy, alex savov, the university of chicago, university of chicago

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