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What is index or passive investing? [video]

Learn how to avoid costly investment mistakes and identify what you really want

An expert lesson in behavioural finance and investing

Professor of finance and world-leading behavioural finance expert Meir Statman says active investing is a game you’ll probably lose. 

Discover why the vast majority of investors should  take the market return instead...and commit to indexing as their preferred investment approach.


Why active management fails and why indexing makes sense

Robin Powell: Meir Statman is one of the world’s best-known experts on behavioural finance. A Professor of Finance at Santa Clara University, he’s written a book called "Finance for Normal People". His central argument is that there’s been too much focus in the past on the irrational nature of investor behaviour. Most people, he says, are far more rational when it comes to investing than is commonly thought, and have perfectly normal wants and needs.

Meir Statman: We want things that are very simple. We want to be rich. We don't want to be poor we want to take care of our kids. We want to acquire high status, some of us want to be true to their values. We want to play games in the market, for example. And once you look at what people want you can distinguish what is a "want" and what is an "error". And then you can help people do better satisfying their wants without falling into the pitfalls of errors.

RP: So, what can ordinary investors learn from Meir Statman’s book? How can they avoid making potentially costly mistakes?

MS: Well the lessons are: Figure out what it is that you want. So, for example, is status important to you? And is your way of getting status by buying alternative investments, like hedge funds? OK. Hedge funds are lovely because they are available only to the rich. And so you can just say "I'm into hedge funds." and we know that you're rich without you bragging about it which is really very very nice. But the returns of hedge funds to investors, not to their managers, are lousy, so ask yourself "Is it worth for me to pay these kinds of fees for feeling that I'm a member of a special club?" You know, alternatively, you can fly first class. You can donate money to charity. There are many ways to increase your status. Figure out what is a good way, an economical way, for you to do that.

RP: Meir Statman is a big fan of indexing. Active investing, he says, is a game you’ll probably lose, so the vast majority of investors should simply take the market return instead.

MS: In the stock market is like playing tennis against possibly Djokovic on the other side. This is not like playing tennis against a training wall. And so you always have to ask yourself "What is the advantage that I have over Djokovic? Do I have an extra size racquet, What do I have?" And for most people the answer is nothing. And so, why play that game when you can just sit yourself on the sideline and get the average return. Remember, for everyone who gets above average return there is going to be someone below average returns so mediocre is beautiful relative to getting below average returns.

RP: So, work out what it is you want from investing opposed to what you need. And if it’s excitement or prestige you’re looking for, you should probably look elsewhere.

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