Dalbar: Active or Passive Funds? 12 Factors to Consider (Beyond Fees)

This spread drops to 0% for a 10-year annualized average, but stands at 0.4% over a 5-year time horizon.

In shorter periods, like the 3-year range, passive funds top active by 1.7%. They also outperform on a 1-year basis at an annualized rate of 2.7%.

The group’s study emphasizes the “unregulated and unaccountable nature” of the indexes tracked by passive funds.

It also highlights the relative “closeness” of the different performance results of active and passive funds, which suggests that investors and advisors should look beyond investment characteristics and “always include situational factors applicable” to individual investors. 

The following 12 features should be considered (along with costs) when picking active and passive funds, according to Dalbar:

1. Design objective
2. Role of investment manager
3. Investment selection
4. Investment return objective
5. Changes to fund portfolio composition
6. Diversification
7. Asset allocation
8. Other capital preservation
9. Regulation of investment decisions
10. Performance measurement
11. Vulnerability to imprudent action
12. Down-market retention

Dalbar ends its analysis by looking at the “temptation” of passive funds, which are based in indexes that get coverage “every second on television or Internet-based services, every day in newscasts and when news magazines are published.”

This barrage of information invariably “creates concern for one investor or another,” the research group says. As a result, we see “imprudent investing in response to excessive exuberance in the news and untimely cashing out when claims of catastrophes are made.”

Such moves often result in investors “buying at market highs and selling at low points,” leading to “a significant loss of return for the average investor.”

— Related on ThinkAdvisor:

• The 5 Deadly Sins of Investing
• Market Timing Costs Investors Big: Dalbar
• Lou Harvey: Retirement Advisors’ Value Is Misunderstood