Investing for the Long Term

CHAPTER 6Passive and/or Active Management

We have made up our mind that investing our savings in equities is the way to go, safe in the knowledge that they offer the best relationship between risk and return. Now we have to tackle the next step in the investment process: deciding how we gain exposure to stocks.

The markets offer a range of options, creating confusion which can only be penetrated on a sporadic basis. But there is no reason to be pessimistic, because the problem can be simplified. If we focus on what's available, we can see that there are four options on offer for investing in equities:

1. Passive management (via Index Funds [IF] or Exchange-Traded Funds [ETF]).
2. Active management:
   • fundamental index funds
   • active managers
   • direct investment in shares.

Mutual funds cover three of the four options for investing in equities, but despite this, in my home country of Spain, 60% of people don't even know what a mutual fund is. So, for the sake of clarity, a mutual fund is a collective investment undertaking which brings together funds from different investors to invest in a variety of financial instruments. The responsibility for the latter is normally delegated to a fund manager. There are thousands of funds available across the world, catering to all types of investors.

Professional money management is currently at something of a cross-roads. Investors are tired of paying high fees for products offering little value-added – only 7% of funds beat the indexes in the United ...