Passive investment management does not use investment managers and research staff to constantly review and change a portfolio. Rather, it simply seeks to replicate a market or index and will provide the market return, less a smaller investment management cost.
Some people feel that, psychologically, they would wather have a well-spoken, well-accredited professional money manager at the helm of an investment portfolio, but another way to look at a passive investment strategy is to consider that you are benefiting from the advice of ALL active managers with a discount on cost for their service. The market is essentially the sum total of all active managers' decisions put together, and as we stated before, they all think they are better than average but this is not possible mathematically. Since no-one has devised a system for pre-selecting the next great manager, you may be better off just using them all, by buying a passively managed index fund.
Don't take our word for it though. Dr. William Sharpe, Nobel Laureate for his contributions to the Capital Asset Pricing Model and Modern Portfolio Theory, wrote a classic paper on the Arithmetic of Active Management. He provides a proof that the passive investor will beat the aggregate actively invested dollar since active investors pay more for their portfolio advice. The paper is a very quick, simple read – click here to read the paper.
Further, even the Father of Security Analysis, Benjamin Graham had this to say in 1976:
I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook Graham and Dodd was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost.
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