The sales pitch from your bank sounds compelling: "Our expert fund managers will help you beat the market with their stock-picking skills." Many Europeans trust their bank and put their savings in these actively managed funds.
But here's what they don't tell you: over 75% of these active funds fail to beat their benchmark index. Even worse, you're paying them high fees for this underperformance.
There's a better way to invest. By understanding why passive investing consistently outperforms active strategies, you can make smarter choices with your money and avoid common investing pitfalls.
Understanding active vs passive investing
What's active investing?
Active investing is when you try to beat the market's average returns by actively buying and selling investments, rather than simply holding them long-term. Think of it like being a chef who's constantly tweaking their menu versus someone who sticks to tried-and-true recipes. Active investors frequently buy and sell stocks, bonds, or other investments. For that, they have to monitor the markets closely and analyse companies in detail. And they try to time their purchases and sales based on market conditions. This is called market timing.
The main goal is to outperform passive investment strategies like buying and holding ETFs index funds. However, research shows that most active investors actually underperform the market over long periods, especially after accounting for higher fees and trading costs. More on why below.
What's passive investing?
Passive investing, also known as index investing, is essentially a "buy and hold" strategy where investors aim to match the market's returns rather than beat them. Imagine it like setting your investment on autopilot – you choose a destination (your financial goals) and stick to the course with minimal adjustments. So instead of constantly trying to be smarter than the rest as with active investing, you simply follow the market.
Instead of trying to guess which individual companies or even which countries will perform best, a passive investor might buy a global equity index fund that includes thousands of companies across the world. For instance, rather than trying to decide whether to invest in Apple vs Samsung, or whether Japanese stocks will outperform European ones, you'd own small pieces of all of them.
The most common form of passive investing is buying ETFs, which automatically track specific market indexes like the S&P 500. These funds simply mirror the performance of all the companies in that index.
Passive investing is a proven way to grow your wealth. It turns out that it's usually more profitable to invest in the whole stock market, rather than trying to time buying and selling individual stocks. Instead of finding the needle in the haystack, you buy the entire haystack. y effectively becoming part owner of thousands of stocks across the world, index investing lets anyone earn a dividend off of the growth of the world economy.
The graph below shows the growth of the S&P 500 index since 1992. A €10,000 investment in 1992 would have resulted in almost €300,000 by the end of 2024, or an average 11.0% return per year!
To summarise:
- Active investing: choosing individual stocks or funds to beat the market.
- Passive investing: aims to match the market using low-cost index funds or ETFs.
Why active investing underperforms passive investing
I turns out that passive investing almost always beats active investing. And it doesn't matter whether you're an individual investor, or a professional. There are several reasons why.
Stock picking is very hard
Some people manage their own portfolio of individual stocks. It's fun and exciting, it's easy to get started by installing any of the neo-broker apps, and you get to invest in the companies you love. But in all likelihood, your return will be inferior to a portfolio of index funds.
First of all, it is very time-consuming if you want to do it well. And you should if you're investing your life savings! You need to do the research to convince yourself that a particular stock is undervalued by the millions of investors around the world. You then need to decide when you will sell. It's best to decide this up-front to reduce the risk that you will make investment decisions based on your emotions. An investor's emotions are his worst enemy.
Also, when you buy a stock, you have to remember that there's another person on the other side of the transaction who's selling you their stock. Every transaction in the stock market is basically a trade in opposing views. This other person can be an individual investor like yourself. But only about 15% of trading happens by individual investors like you and I. So most likely, they're a professional at a hedge fund, a large bank or another financial institution. And there's a good chance that they have access to much better information than yourself that made them decide to sell the stock. Investing is their livelihood, and they have entire departments of analysts supporting him in his work. So from the moment you buy the stock, the odds of the bet turning in your favour are already against you.
There's also a real risk if only invest in one particular company. Think, for example, of Volkswagen's emissions scandal or Wirecard's fraud affair.
The fee burden: active funds must work harder to win
Active funds are more expensive than passive ETFs and index funds. It's simple and cheap to track an index: just buy what's in the index and keep it updated. But active investors pay more trading fees and have research expenses. They also require fund managers, analysts and other specialists to do the research and make investment decisions. These people are usually very handsomely paid.
Imagine both an ETF and an active fund start with €100,000, and the market returns 7% in a year. The ETF charges 0.2% in fees, while the active fund charges 2%.
ETF:
- Market return: 7% (€7,000)
- Fees: 0.2% (€200)
- Net return: 6.8% (€6,800)
Active fund:
- Must earn: 8.8% (€8,800) before fees
- Fees: 2% (€2,000)
- Net return: 6.8% (€6,800)
So the active fund must outperform the market by 1.8%, just to cover the fee difference and be equal with the ETF. That's already a challenge!
This mathematical reality plays out in real-world examples. Take KBC Equity Fund World, an active fund that aims to beat the MSCI ACWI index. With ongoing costs of 1.71%, it needs to outperform by 1.51% just to match an iShares MSCI ACWI ETF (TER: 0.20%) tracking the same index. And we can see by historical performance that it struggles. Between 2005 and end of 2024, the ETF yielded an average yearly return of 9.2%. Compare that with the 5.5% return of the active fund! TEven though the active fund's goal is to beat the ETF.
In practice, this explains why the iShares ETF consistently outperforms KBC's fund over the long term. Even if KBC's managers make good investment decisions, their higher fees create a significant performance drag. The active fund must generate exceptional returns year after year just to keep pace with its passive counterpart.
Over long periods, this fee difference compounds dramatically, potentially leading to substantial differences in wealth accumulation for investors.
It's mathematically impossible for all active investors to beat the market
Imagine the entire market is made up of only two groups of investors:
- Active investors who trade frequently, trying to beat the market
- Passive investors who simply buy and hold the market
Here's the key insight: before costs, these two groups must achieve the same average return. Why? Because the market return is simply the weighted average of all investors' returns. It's a bit like a pie - the pieces might be divided differently among people, but they still add up to one whole pie.
But - and this is the crucial part - active investors pay more in costs (trading fees, research expenses, manager salaries). So after costs, active investors as a group must underperform passive investors by exactly the amount of those extra costs.
This means it's mathematically impossible for all active investors to beat the market. Some might succeed, but others must underperform by the same amount. It's a zero-sum game before costs, and a negative-sum game after costs.
This fascinating concept was discovered by Nobel prize winner William Sharpe in his short and readable paper The Arithmetic of Active Management.
Finding needles in the haystack is really hard
Most investors think stock returns follow a predictable pattern - some stocks do well, some do poorly, with most falling somewhere in the middle. Academic research tells a very different story.
The reality is far more extreme. Most stocks actually perform dismally, while a tiny group of superstar companies drive the majority of market returns. Studies paint a stark picture: about 60% of stocks deliver returns lower than risk-free government bonds over their lifetime. Even more sobering, around 40% of stocks end up with negative lifetime returns.
Here's the kicker - just 4% of stocks account for all of the market's gains above the risk-free rate. Think about that. A handful of companies like Apple, Microsoft, or Amazon have generated an outsized portion of all the wealth created in the stock market.
This creates an enormous challenge for active investors trying to pick individual stocks. It's not enough to find good companies - you need to identify these rare exceptional performers in advance. Miss these few superstar stocks, and your portfolio will almost certainly underperform the market.
This reality explains why index investing is so powerful. When you buy a broad market index fund, you automatically own all of these superstar stocks. You don't need to guess which companies will become the next Apple or Amazon. By owning tiny pieces of everything, you ensure you'll capture all the winners that drive market returns.
In essence, trying to pick winning stocks isn't just difficult - the maths shows it's extraordinarily hard to get right consistently. Index investing elegantly solves this challenge by simply owning everything.
Both professionals and individual investors struggle to beat the market
The challenge of beating the market through active investing isn't just a problem for individual investors - professional fund managers struggle just as much, despite having advantages that individual investors can only dream of.
Professional fund managers have impressive resources at their disposal: teams of analysts, sophisticated research tools, direct access to company management, and advanced trading platforms. Yet the ESMA, the European regulator for the finance industry, found that more than 75% of active funds underperform against their index benchmark. On top of that, the group of top 25% active funds changes constantly. There's a good chance that a top fund of the last 5 years won't be nearly as good over the next 5 years. So it's almost impossible for investors to consistently pick outperforming active funds.
Individual investors, probably like yourself, often fare even worse. Without the resources of professional managers, we face additional challenges, like limited access to research and information and higher trading costs. Our brains are also more inclined to work against us.
The disposition effect is the tendency to sell stocks that have increased in value while keeping stocks that have dropped in value. This prevents us from selling poor performers and buying potential winners. The home bias and the disposition effect are examples of irrational, behavioural biases that negatively affect our decisions when dealing with individual stocks. The Nobel-prize winner Daniel Kahneman has documented many of these in his brilliant book "Thinking, Fast and Slow". Unfortunately, these biases are wired into our brains. So they're extremely hard to ignore, and they're an important reason for the underperformance of stock pickers.
When investing in individual stocks, most will stick to their home market, or stocks that they know. As a Belgian, you're more likely to invest in companies like Proximus or Solvay than a Swedish or Brazilian company. The home bias among Belgian investors is 45%, even though the market cap of the Belgian stock market is only 0.24% of the global market. Yet there's no reason why Belgian stocks perform better than Swedish or Brazilian stocks. On the contrary, the historical performance of the BEL 20 would indicate the opposite.
This universal struggle against passive investing isn't surprising when you consider the earlier points about fees and the skewed nature of stock returns. Both professionals and individuals face the same fundamental challenge: they need to find those few exceptional stocks that drive market returns, and they need to do it well enough to overcome their higher costs.
The advantages of passive investing
It should be clear by now that active investing is very hard. In contrast, passive investing is a much better way to investment success. In fact, we think it's the best way for most Europeans to grow their wealth.
Low cost
One of the problems associated with active investing are the high fees. Passive investors pay lower fees because index funds and ETFs are cheap to run. It's simple to track an index: all that is required is buying the stocks in the index, and update when the index changes. It doesn't require expensive analysts or other specialists.
Diversified
One of the goals of passive investing is to diversify as much as possible. We saw that an ETF such as "iShares MSCI ACWI" invests in 2,800 companies across 47 countries. Through diversification across many countries and sectors, you eliminate unnecessary risk. And you also benefit from the growth of the best companies in the world, not just the large German, French or American companies you know. By investing in as many companies as possible, you're almost sure of including the winners, namely the minority of stocks that are responsible for most of the returns.
Rooted in the real economy
Most index funds invest either in stocks or bonds. Those are backed by real companies, with real factories, employees, intellectual property, and so on. This is unlike, for example, the crypto space, where the value of a currency or token is mostly determined by its potential rather than by concrete applications.
You can buy and sell whenever you want
Index funds and ETFs are very easy to buy and sell. If you wish to, you can trade any index fund within minutes. In finance jargon, we say that index funds are "liquid". This is an advantage compared to other types of investments such as real estate or art. For instance, when selling a house, it can take a long time before finding the right buyer.
You can invest with low amounts
Another advantage of passive investing is that you don't need a lot of capital to get started. You can even invest with as little as €50. This makes passive investing possible for everyone, especially young people who just started their career and want to grow their wealth by putting their savings. In contrast, real estate is much less accessible. Just the down-payment for a property requires several tens of thousands of euros. In fact, it's often easier to invest in real estate through ETFs that focus on real estate companies.
It's tax-efficient
In most European countries, investing in the stock markets is tax-efficient compared to other types of investments. Some countries like Belgium even don't tax profits from investments in stocks, making passive investing particularly tax-efficient for them.
Great for beginners
Passive investing is one of the best ways for new investors to start investing. It's a proven strategy and doesn't take too much time to set up. Furthermore, it's a lot less risky than investing in individual stocks, or trading in highly leveraged instruments like options of CFDs.
Drawbacks to passive investing
Of course, it's not all rosy. Passive investing also has drawbacks.
The stock market goes down from time to time
It's no secret that the economy ebbs and flows. Because of these fluctuations, it's important to maintain a long-term view when investing. An investment horizon of 10 years or more is ideal.
Less control over what you invest in
When you invest in an index fund, you let the underlying index provider choose all the stocks in the index. For instance, when you invest in the S&P 500, you can't choose the companies you invest in because you have no say over the composition of the index. Only Standard & Poor's, the company behind the S&P 500, can.
This may be particularly worrisome for those who do not wish to invest in certain companies with poor ethical values or negative impacts on the environment. Fortunately, fund providers are increasingly creating funds that exclude companies they deem unethical or that do not meet sustainability criteria.
Should you invest passively or actively?
Let's summarise the differences.
At Curvo, our point of view is clear: we think passive investing is better than active for most people. Only when you are willing to dedicate to your investments several hours per week for decades, and you think you have an edge over the other investors in the world, do individual stocks make sense. But for most people, investing is simply a tool to build a better financial future. They'd rather spend their time on things they really care about, like their family, friends and hobbies.
We thank active investors
We actually need active investors to determine the correct price of an investment, such as a stock. If everyone invests passively, no one makes that analysis anymore, so the price of stocks risks deviating from what their price "should be" be. In other words, the stock market then becomes less efficient. We therefore thank all active investors for setting the prices right so that we passive investors can benefit!
Why Curvo advocates for passive investing
At Curvo, our mission is to make passive investing accessible to young Europeans. We offer a platform that simplifies investing through diversified portfolios of index funds, helping you prepare for your financial future without the complexities of active management.
We understand that it can be difficult to build a portfolio of ETFs that's right for you. We started Curvo to solve this problem and make passive investing easy and accessible to everyone.
Creating an account on Curvo starts with answering a questionnaire on your investment goals and your appetite for risk. You’ll then be assigned the best portfolio of index funds that matches your goals and risk tolerance. Each portfolio is globally diversified and invests in over 7,500 companies so it's a lot more diversified than one individual stock.
Learn more at how Curvo works and how you can put your savings to work in only a few minutes.
Conclusion
The debate between active and passive investing often comes down to a simple question: do you want to try beating the market, or would you rather join it? History shows that passive investing through index funds offers the most reliable path to building long-term wealth. With lower costs, better diversification, and less stress, it's no wonder that more Europeans are choosing this approach.
Want to learn more about putting passive investing into practice? Consider reading our guide on how to get started with index investing, or explore how Curvo can help you build a properly diversified portfolio.