Passive versus active: Which investment style is best?

Passive investing has taken off over the past 20 years, with the increasing popularity of exchange traded funds (ETFs) and some surprising champions.

Legendary investor Warren Buffett has built his reputation and his fortune on picking winning stocks, but he thinks most of us would be better off investing in passive index funds.

In his 2017 letter to investors, Buffett wrote: “When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”

The table below showing the percentage of Australian fund managers who underperformed their benchmark index suggests he is right, on average. However, some active managers do what they say they will do and beat the market.

So what approach works best?

Before you compare performance, it’s important to understand the difference between active and passive investments and the trade-off between performance and fees. Even Buffett says he’s prepared to pay high fees to managers who deliver market-beating returns.