What is the best way to invest? There are many active traders trying to cash in on meme stocks like AMC and GameStop, Snap and Peloton, or fads like bitcoin and other cryptocurrencies. Professional money managers try to identify stocks that can outperform the broad market over the long term.
But for most individual investors, the strategy of buying and holding so-called passive funds that track top indexes like the S&P 500 and Nasdaq 100 makes sense if you’re looking to build wealth for retirement. The infomercial for that familiar old chicken fuel is like the slogan: set it and forget it.
Index funds tend to be cheaper. New data from S&P Dow Jones Indices showed investors saved more than $400 trillion in fees with index funds over the past quarter century.
Of course, index provider S&P Global (SPGI) has a strong interest in promoting passive funds hedged across various benchmark indices.
The company, along with competitors such as iShares owner BlackRock ( BLK ) and index provider MSCI ( MSCI ), offers many options for investors looking to gain exposure to the broader market without trying to pick individual winners and losers.
Even legendary investing guru Warren Buffett of Berkshire Hathaway ( BRKB ) has extolled the virtues of index funds for the average investor. That’s because Buffett, despite being one of the most successful stock pickers of all time, doesn’t believe most active investment managers can beat the broad market.
The 92-year-old Oracle of Omaha wrote in Berkshire’s 2014 annual shareholder letter that his advice to the trustee of his estate was to “put 10% of cash in short-term government bonds and 90% in very low-cost.” S&P 500 index fund” for his wife. (Buffett suggested one at Vanguard.)
“I believe the long-term results of trusting this policy will be greater than those achieved by most investors – pension funds, institutions or individuals – employing high-fee managers,” he wrote.
And given that some high-profile active investors have lagged the market recently, there’s something to be said for conservative investors betting on the S&P 500 for the long term.
Just look at Cathie Wood at Ark, who has made big bets on companies like Tesla ( TSLA ), Zoom ( ZM ), Roku ( ROKU ), and Teladoc ( TDOC ). Ark’s flagship Innovation ETF is down 60% this year, compared to a 20% drop for the S&P 500.
“Actively managed funds have been unable to survive and outperform their benchmarks, especially over longer time horizons,” said Bryan Armour, Morningstar’s North American director of passive strategy research, in a report last month. It noted that only one in four active funds beat their passive benchmarks in the ten years ending in June.
Of course, buying index funds is no guarantee of investing success either…especially not in the short term. After all, the S&P 500 is down again this year.
“Diversified portfolios typically do well, but they’ve been hit hard recently by rate hikes,” Shamik Dhar, chief economist at BNY Mellon Investment Management, told CNN Business in an interview.
Even the vaunted 60/40 asset allocation recommendation for investors, meaning owning 60% stocks and 40% bonds, has so far failed to outperform the market in 2022.
“This year, there seems to have been a widespread source of fear. It’s shock therapy. Growth and inflation are slowing. That’s disorienting investors,” Adam Hetts, global head of portfolio construction and strategy at Janus Henderson Investors, told CNN Business in an interview.
On that note, any investor with a decent exposure to bonds, thinking they would be better off in the tanks of stocks, has gotten a rude awakening. The iShares 20+ Year Treasury Bond ETF (TLT), the leading long-term bond proxy, has done even worse than the stock market, falling more than 35% this year.
That’s why some investors aren’t singing the funeral dirge for active stock picking, just yet.
“The 10-year ‘secular bear market’ is underway,” Stifel chief equity strategist Barry Bannister said in a recent report. which predicts that the market may be stuck in a tight range for the rest of the decade.
“We believe that this environment favors the following approach: active management (not broad passive),” he said.