Two broad approaches to choosing investments for your portfolio are passive investing and active investing. Active investors believe that they (of their money managers) possess the ability to choose winning investments and “beat” the market. Some active investors choose market timing strategies while others choose stock-picking strategies. Unfortunately, on average, most investors are average. In the end, many active investors discover that they cannot beat the market. In fact, many discover that they underperform the market because of the fees involved with trying to actively manage the portfolio.
Enter passively-managed index funds. Proponents of passive investing claim that the best investment decision is to match the market return, and even better, to do so at the lowest possible cost. This investing style chooses financial assets that mimic an index.
According to this USA Today article (Waggoner, 20 Mar 2014):
Your basic index fund boots the manager and selects its stocks (or bonds, or other securities) according to an index, such as the Standard and Poor's 500. Until recently, most stock indexes weighted their holdings according to the market value of the stock.
The article goes on to describe other weighting schemes for passively-managed funds such as equal weighting or rules-based funds. Whether these other weighting schemes are wise is debatable, of course. According to the article, any scheme that deviates from a traditional market value weighted index is just another form of active trading. In the end, a true passively-managed fund may still be the best investment idea.
· According to the article by Bill Sharpe found here http://www.stanford.edu/~wfsharpe/art/active/active.htm, what are the differences between active and passive investors? Why must the actively managed fund underperform the passively managed fund?
· According to the USA Today article cited in the post above, what are the limitations associated with a market-value (or market-cap) weighted index fund?