PART 1: Beyond the “Active versus Passive” Debate

At the most basic level, there are two investment strategies: Active and Passive. Active investing is when one tries to outperform or “beat” the stock market, using one or more strategies. Investment managers charge a fee for this service, and also incur costs for their frequent stock trades, which are passed along to the investor—you. On the other hand, passive investing is when, instead of spending money aiming to beat the market, one closely “mimics” or follows the market itself. Fees are much lower in passive funds, as are transaction costs.

Passive investors recognize that the results of active strategies are entirely unpredictable. They have come to accept the disclaimer “past performance is no guarantee of future results” as a truism, realizing that their lower costs alone will substantially add to their investment growth.

A penny saved is indeed a penny earned.
Did you know most passive strategies have much lower costs and fees than active ones? An online calculator shows the impact can be significant.  

What historical data teaches Index-fund giant Vanguard reports that over a 20-year period, the broad stock market index funds have outpaced 60 percent of actively managed funds. Research firm Morningstar, Inc. reported that in 2008, average losses for stock-index funds were 39.1%, while actively managed funds lost 40.5% on average.  But is underperformance true over all asset classes?

The Cost Matters Hypothesis Whether markets are efficient or inefficient, investors as a group must fall short of the market return by the amount of the costs they incur. —John C. Bogle, Founder of Vanguard Group According to Morningstar, index funds have an expense ratio of about 0.9% of the fund's value (even lower for index ETFs), while mutual funds have expense ratios that average closer to 1.3%.

Click 'Next' for Part 2: Inside an Index

[1. Why indexing?] [2. Inside an index] [3. Evidence it works] [4. Making the choice]