by Jason Jenkins Thursday, February 23, 2012 Wisdom of Wealth

Are you a control freak? Or do you just like to go with the flow?

Well, there are investment strategies for you, regardless of your preferences.

An active investor believes he can pick out just the stocks in the market that will have the best returns. An active investor bets that he, or his fund manager, can use good research and judgment of a company’s fundamentals to find mispriced assets, such as stocks and bonds.

Passive investing, on the other hand, is a strategy where you or your fund manager invests in accordance with a pre-determined strategy that doesn’t entail any forecasting.

That’s the dictionary definition anyhow, but I think it’s easier to understand it this way:

A passive investor wants to own all the stocks of the market or an index because she thinks, as a whole and over long periods of time, that market will outperform any stock or bond picker. So by investing in that entire market or index, she is likely to receive higher returns than by trying to pick the individual stocks that will outperform the market as a whole.

And the biggest benefit to passively investing is… drum roll please… less transaction fees.

How Do Average Investors Passively Invest?

Retail investors typically do this by buying an index fund or ETF. If you track an index, an investment portfolio typically gets good diversification, low turnover (good for keeping down internal transaction costs) and extremely low management fees.

With low management fees, an investor in such a fund would have higher returns than a similar fund with similar investments, but higher management fees and/or turnover/transaction costs.

Passive management is most common on the equity market. There you have index funds that track a stock market index. However, now we’re seeing passive management branching out to other investment vehicles, including bonds, commodities and hedge funds.

Another factor playing into the rise in passive investing and management is the emergence of the global economy. It seems that everyone and their grandmother all have some sort of global market index that tracks almost everything in every sector.

Through mutual funds and ETFs, indexing now accounts for about $1.6 trillion in investor assets.

Better Results

Over the 23 years ending in 2009, actively managed funds trailed their benchmarks by an average of one percentage point a year. If a benchmark like the Standard & Poor’s 500 returned 10%, the average managed fund investing in similar stocks would therefore have returned 9%, while an index fund would have returned 9.8% to 9.9%. With some of that loss due to fees.

Even with this information out there, investing in index funds, or passive management, accounts for only about 13% of assets in mutual funds holding stocks.

Investment U Chief Investment Strategist Alexander Green even wrote a New York Times -bestselling book about the benefits of passively managed portfolios called The Gone Fishin’ Portfolio .

And The Oxford Club actually tracks the portfolio Alex recommends in his best-selling book. And the average gain of The Gone Fishin’ Portfolio’s 10 positions is 140.4% over the nine years since its inception.

Passive investors believe it’s nearly impossible to beat the market consistently over the long run. Instead, betting with the market will win out over the long term – and the numbers are beginning to show some truth in this approach.