• Market Gains are Zero Sum – If the stock market goes up 5% on the year, that means 5% more wealth has been created. If someone beats the market with an 8% return, that means someone else under perform by 3%. We all can’t be winners.
• 70-80% Can’t Outperform the Market: It isn’t a matter of having one winner and one loser. Most people end up losing. Active mutual funds that try to beat the market will usually fail about 80% of the time. Not only will they fail, but they’re going to charge you higher fees for it too.
• Winners are Random: Research has shown that you can’t look at a mutual fund’s past performance to get an idea of how they’re going to do next year. Typically the one at the top of the pack, is the loser next year.

If you’re looking for information on research that backs up these claims than I suggest you take a look at “The Power of Passive Investing” by Ferri. He did a really good job showing the main points I listed above.

Why Use Passive Investing?

Like I mentioned earlier, most people will fail to beat the market. And over a long enough time line the winners will turn to losers. Passive investing just follow the bench marks, so that is the type of return you expect. As you know, following the S&P500 and S&P/TSX Composite will produce great results on their own.
At the end of the day, you’re more likely to lose playing the active investing game. The more stocks and funds you add to the portfolio the more the odds of you losing increase. Here are a few positives to consider:

• Cheap MER for ETFs and Indexes: MER stands for Management Expense Ratio. Essentially it is the cost of owning a fund be it a passive index mutual fund/ETF or an active mutual fund/ETF. Since a passive fund doesn’t need to hire overpaid stock pickers they can really reduce the cost of the fund. In Canada passive index will run in the range of 0.30-0.50%. Where as an active index mutual fund will run in the range of 2%.
• A lot Less Work:  Since you don’t have to try to pick winners and losers you can save a lot of time doing other things. The process becomes the process of just putting the money into your account and following your simple passive asset allocation. More or less you’re just sticking to the plan and putting your money in.
• Less Trading Commissions: Every time you buy a stock you’re going to pay a commission. If you receive dividends, you need to reinvest the dividends and that’s another commission (except in certain situations). The same is true for a passive ETF, but you really only need to own a handful of funds to be well diversified. Think of how many stocks you’d need to own to be diversified. Indexes at some of our banks don’t even have commission prices.

As you can see the passive investing strategy is really quite effective. Instead of playing to win (with high odds of losing), you play to get market returns. Instead of having to invest a lot of time picking winners and losers, you just put your money in to invest to your asset allocation. The key word here is that it is simple and simple works, especially over the long term with your investing.

There are a lot of books that could be written on this subject, but this discussion was a quick overview of what passive investing is and why a lot of people choose to use it.