n Studies in Economics and Econometrics - Active versus passive investing II : towards an optimal combination solution

Volume 29, Issue 2
  • ISSN : 0379-6205


As shown in the first article, index investing, despite its superior performance on average, is not a low risk strategy and investors will experience volatile returns. Over time index investing and active management repeatedly replaced one another as the dominant investment strategy. A fundamentalist approach about any one of the strategies is not prudent and it is argued that an integration approach of both strategies will yield the highest reward per unit of risk.

When following a strategy of combining both strategies in various combinations over different investment periods, it is demonstrated that the highest reward to risk ratio is attained by increasing index investing relative to active investing with an increase in the investment horizon. Simply put, the longer one's investment term, the more index investing should be followed.
In the long run it is difficult for active management to consistently beat the market. Therefore, investment strategies should be aligned with one's faith in the efficiencies of markets over time and should not be overly influenced by the short-term performance records of active managers.

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