The case for passive investing

The passive-investing strategy says that investors should invest continuously and systematically in broad diversified indices, while ignoring the current market level and volatility. This method guarantees an index return, which should beat inflation. The passive concept became popular once the efficient market hypothesis (EMH) was developed. The EMH claims that in an efficient market, it is difficult to consistently outperform a broad well-diversified index. A market is considered efficient when information is rapidly disseminated to all and there is equal ease of trading for everyone. In such an efficient market, new information is rapidly discounted and prices move unpredictably. (This is a very brief definition). Burton Malkiel, author of A Drunken Walk down Wall Street, is one of the most passionate advocates of passive investing. He has made many interesting statistical observations to support his arguments. The 'drunken walk' is a figure of speech that compares the way stock prices move to the way a drunkard weaves around. Some markets are more efficient and no market is perfectly efficient. But there is a high psychological and practical advantage to passive investing in almost any market. Assuming the investor has the mental discipline to do this, he or she can take comfort from an automatic process. There is no need to think about the index level or daily prices or what is happening in news flow; there is no need to pick stocks that may or may not be outperformers. Over time, the investor will receive the same return as the index. This method also ensures continuous investment. Some part of the investor's savings will continuously flow

This article was originally published on September 11, 2015.