Active versus passive investing: What Buffett thinks and why it matters for you
Warren Buffett’s most famous advice is to buy companies with strong moats when they’re available at reasonable valuations. But do you know his second most famous piece of advice? Buy a low-cost index fund.
That’s right. Despite building his wealth through active stock investing, Buffett advises the average investor to pursue a passive approach.
Guess who’s taking Buffett’s advice seriously? The Indian mutual fund industry. With the market booming, the industry is capitalizing on the momentum by launching a slew of new funds.
In fact, a leading daily reported that around 170 new funds have launched this year alone. Surprisingly, passive funds lead the way, with 42 index funds and 36 exchange-traded funds (ETFs) introduced so far. Together, these make passive funds the single largest category of the year.
Before we dive further, let’s clarify active versus passive investing.
Active Investing: This approach involves portfolio managers carefully selecting stocks based on research into fundamentals and valuations, aiming to outperform the benchmark index like the Sensex or Nifty.
Passive Investing: Here, the goal is not to beat the index but to mirror its performance. For example, a Nifty index fund buys all Nifty stocks in the same proportion as they appear in the index.
With definitions clarified, let’s move forward.
Active investing is often considered worthwhile only if it delivers at least 3-5% higher returns than the benchmark after fees. For example, if the benchmark yields 15% annually over a decade, an active manager should aim for 18-20%.
Are active fund managers in India achieving this? Let’s see.
Over the last 10 years, the BSE 100 index has returned a CAGR of 13%. I checked 23 large-cap funds on Moneycontrol,
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