Active vs. Passive

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jkl1v1n6's picture
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This has been talked about numerous times before, I just read this on Marketwatch.  In an effort to move the focus off of Windy, your thoughts?
 

Paul B. Farrell

Jul 7, 2009, 12:01 a.m. EST
Lazy Portfolios seven-year winning streak
Strategy keeps beating S&P 500 as well as popular actively managed funds

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By Paul B. Farrell, MarketWatch
ARROYO GRANDE, Calif. (MarketWatch) -- Guess what? Actively managed mutual funds are bad news, filching your hard-earned money.
Year after year they continue their dark legacy, proving what former Sen. Peter Fitzgerald said during his reform fight five years ago: "The mutual fund industry is now the world's largest skimming operation, a $7 trillion trough from which fund managers, brokers and other insiders are steadily siphoning off an excessive slice of the nation's household, college and retirement savings."

The fund industry defeated the senator's efforts. Back then Morningstar's boss Don Phillips added that funds "lost their moral compass." Today it's far worse. Greed drives this industry. The "world's largest skimming operation" has now lost over 50% of America's savings in the decade since the peak of 2000. The track record of actively managed funds during the recent subprime-credit meltdown continues to prove that the industry is failing America.
The only way to invest is with index funds, which make up just 14% of the total. As "Kiplinger's Annual Guide" once said about building index-fund portfolios: "If you're picking from among the best funds to start with, then all you really need for diversification is three stock funds and one bond fund -- and you can forget the other 9,111 funds." Yes, forget about 99.9% of all mutual funds.
As Vanguard's founder Jack Bogle succinctly put it: "Common sense tells us -- and history confirms -- that the simplest and most efficient investment strategy is to buy and hold all of the nation's publicly held businesses at very low cost. The classic index fund that owns this market portfolio is the only investment that guarantees you with your fair share of stock market returns."
A portfolio of index funds does the trick because it's diversified broadly across more than a thousand stocks and bonds in the market.
Let's rumble: lazy investors vs. active-managed competition
Still skeptical? OK, the facts, and a competition. Let's compare the performance of a half dozen of America's most popular actively managed funds touted in ads and the financial press over the years. We'll compare them to our eight Lazy Portfolios. As you do, keep in mind one crucial point: The big sales pitch for actively managed funds is that their managers are supposed to "add value" by beating the market indexes, right? Wrong.
For comparison, we picked six perennially popular funds: Fidelity Magellan, Dodge & Cox Stock, Legg Mason Value, Ja*** Fund, Baron Growth and American Funds' Washington Mutual.
And keep in mind the compensation paid to the managers of America's hot-shot funds typically equals 10 or more times the income of the average American. Unfortunately, as you'll see, they still lost a lot of their investors' money.
By comparison, all eight Lazy Portfolios are already sporting positive average annual returns on a 5-year basis. Plus they also beat all six of the popular actively managed funds on 1-year and 3-year average returns. I repeat: All eight Lazy Portfolios are outperforming every one of these popular actively managed funds. Apparently these actively managed funds exist for only one reason ... to make their managers rich, not their own investors.
First, notice that three of these actively managed funds barely matched the performance of the S&P 500 the past year. In addition, the other three underperformed the S&P 500 by three to seven percentage points.
In short, even though we know that the average compensation of portfolio managers is often $400,000 to more than a $1 million, the hot-shot managers of these actively managed funds provided no value-added to their funds' performance. Conclusion: Their investors would be better off investing in index funds.

Popular funds
1-year return
3-year annualized return
5-year annualized return

Fidelity Magellan
-33.5%
-9.78%
-3.51%

Dodge & Cox Stock
-29.4
-12.7
-2.82

Legg Mason Value
-28.2
-18.9
-10.4

Ja*** Fund
-25.8
-5.51
-2.02

American Funds Washington Mutual
-25.3
-8.53
-2.32

Baron Growth
-25.2
-7.83
0.54

S&P 500
-26.2
-8.22
-2.24
As of June 30, 2009
Now, let's compare the performance of those six actively-managed funds to the performance of our eight Lazy Portfolios as of midyear 2009. Notice that all eight Lazy Portfolios beat the benchmark S&P 500 across the board for all three time periods. Yes, the market was in negative territory the past few years, but still all eight Lazy Portfolios outperformed each of the six actively-managed funds.

Lazy Portfolio
Number of funds
1-year return
3-year annualized return
5-year annualized return

Aronson Family
11
-18.7%
-3.06%
2.76%

Fund Advice
11
-15.8
-2.18
3.12

Smart Money
9
-15.9
-3.70
1.58

Coffeehouse
7
-15.0
-3.69
1.46

Yale U.
6
-21.8
-5.02
1.72

No-Brainer
4
-19.8
-4.74
1.08

Margaritaville
3
-19.8
-3.03
2.26

Second-Grader's
3
-24.3
-6.07
0.68

S&P 500

-26.2
-8.22
-2.24
As of June 30, 2009
These are midyear numbers. You can also find automatic daily updates at You can also find automatic daily updates at MarketWatch.com/lazyportfolio.
Here's why Lazy Portfolios are a winning strategy. It's based on the Nobel Prize-winning Modern Portfolio Theory: Simple well-diversified portfolios of three to 11 low-cost, no-load index funds that require no active trading, no management. You let them do the work passively without tinkering with allocations. Just add new money from your regular savings to rebalance and build your retirement nest egg.
(Warning: Wall Street bankers and brokers hate the Lazy Portfolio strategy because they can't get rich on index funds, no front-end commissions, no excessive annual management fees).
Six rules for success
Now here's how it works: Six simple rules guaranteed to help you diversify, lower risks, level out bull/bear cycles and generate returns that beat the indexes without buying high-expense actively managed funds or wasting your valuable time playing the market. Customize your own Lazy Portfolio following these six rules and you'll win. More important, you'll have lots of time left to enjoy what really counts, your family, friends, career, sports, hobbies, living.



  1. Market timing is for chumps and chimps. The market's random, irrational and unpredictable. You can't beat it. It loves humbling the mighty. Active trading makes no sense for America's 95 million passive investors, because fees, commissions and taxes kill returns. Besides, Prof. Terrance Odean's research proves: "The more you trade the less you earn." Back in the '90s a chimp throwing darts beat the stock market, made a monkey out of Wall Street. It's easy, you can too.

  2. Frugality, savings versus financial obesity. Tools like starting early, autopilot saving plans, dollar-cost averaging, frugal living and other tricks are familiar to long-term investors. Trust your frugality instincts -- living below your means -- it's a trait common among America's "millionaires next door."

  3. The explosive power of compounding. Albert Einstein, the jolly genius "Man of the Century," says that compounding is the world's most powerful force. Regular savings -- expanding explosively, building on top of itself -- is money power. Start early, with just $100 a month, you can retire a millionaire.

  4. Diversification -- the lost art of being average. Don't be greedy, be average. If you put all your eggs in one basket, like speculative condo-flipping, and it goes belly-up, you end up with a burnt omelet. Dividend reinvestment guru Chuck Carlson's says: "Swing for singles." Just being average wins.

  5. Buy (quality) and hold -- and you'll never sell. Ignore all the latest desperate Wall Street hype about "the death of buy and hold." They want to con you into paying their high fees and commissions. Warren Buffett's favorite holding period is "forever;" his best time to sell is "never!" So ignore Wall Street's "tips," do your homework, buy index funds with the idea you'll never sell, and win.

  6. Do it yourself: The Tortoise consistently beat the Hare. Think long-term: I remember Ric Edelman's amazing research: Millionaires spend less than three hours a month on personal finance, just six minutes a day. So, when you're ready, step up to the starting line and race like a tortoise. Discover how America's slowest, laziest portfolios get you on the road to retirement as a enlightened millionaire.

So that's our little crib sheet on how to build a lazy retirement portfolio. For more info, check out my book, the "Lazy Person's Guide to Investing." This method is so easy even a second-grader can grasp this stuff. In fact, one did, as you'll see at MarketWatch's Lazy Portfolios, where we automatically update all eight portfolios at the end of every trading day.
Do it and have fun knowing that you'll be beating the S&P 500 plus beating America's popular actively managed funds. But whatever you do, please don't spend too much time on investing, not just because it's a waste of time, but because there really are more important things in life: Loved ones, family, mom, dad, best friends, and doing stuff you love, that makes you happy.

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Moraen's picture
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I agree. If you are going to invest in mutual funds, why not index funds?

However, I think security selection is extremely important and when you buy is extremely important.

The tests for MPT are like most economic theories and are tested in a vacuum. Also, the percentage of investment returns that asset allocation is responsible for changes as you talk to different people.

anonymous's picture
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Conclusion: Their investors would be better off investing in index funds.

Popular funds
1-year return
3-year annualized return
5-year annualized return

Fidelity Magellan
-33.5%
-9.78%
-3.51%

Dodge & Cox Stock
-29.4
-12.7
-2.82

Legg Mason Value
-28.2
-18.9
-10.4

Ja*** Fund
-25.8
-5.51
-2.02

American Funds Washington Mutual
-25.3
-8.53
-2.32

Baron Growth
-25.2
-7.83
0.54

S&P 500
-26.2
-8.22
-2.24
As of June 30, 2009
Since I have the numbers handy, let's compare the S&P 500 to Washington Mutual.  Washington Mutual was started on 7/31/1952.  A $100,000 investment would now be worth $46,741,187.  The same investment in the S&P would be worth roughly half of that $24,196,677.
 
Conclusion: Index fund investors would be better off investing in active funds.
 
(I think that both conclusions are incorrect and the active vs. passive debate is just plain stupid.)

B24's picture
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To me, the bottom line is, regardless of which approach you use, is that you have to execute well.  Any knucklehead can buy an index fund, but it doesn't mean it will turn out well (what if someone bought the SPY in 2000 and held for 10 years?).  However, rotating correctly, the correct basket of index funds did alright the past 10 years.  Conversely, you can compare First Eagle Global to Legg Mason Value, and see that FEG crushed Bill Miller's entry.  So I find it stupid when writers pick arbitrary (or not so arbitrary) funds and indexes to use, as it does not necessarily reflect actual investors results.
However, for the complete novice, just picking a well diversified complement of indexes is probably the least likely to screw you up, so long as you stick to it.
 
One other thing - each of the "Lazy" portfolios above includes a healthy dose of bonds and other asset classes (during the worst 10-year period for equities).  And his actively managed funds are all equity.  So right there it is an incomplete comparison.  If he had compared them from 1995-1999, I bet the result was the exact opposite.  So as someone else mentioned, timing matters.

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A couple of points.

I like b24 says in evaluating the portfolios you are talking about comparing Washing Mutual(The fund invests in stocks that meet strict standards evolving from requirements originally established by the U.S. District Court for the District of Columbia for the investment of trust funds. May not invest in companies that derive their primary revenues from alcohol or tobacco.) and comparing that to the Yale portfolio(with commodities, reits and other alternative classes).

Second, There is some validity to the performance of passively managed portfolios. Paul Farrell is a windbag with a deadline to meet. Consequently, his columns on Marketwatch are either about his "Lazy Portfolios" or what doom and gloom we are headed for. Farrell is always short on data. His columns back in the late 1990's, you would have read columns glorifying tech-heavy growth investing. How did that turn out.

However I disagree with Anonymous' data because lets face it retirees don't have don't have 57 years(2009-1952) to find out if that happens again(and not take income from it). Although he maybe be right about the numbers they don't really apply.

I love how these articles always take famous(or infamous funds) that no one should use and have them be the bench mark and most are based on large cap growth funds. but then compare those results to vanguard's whole portfolio of funds(real estate, int'l, bonds, commodities). Next thing you know DFA will come back into the mix.

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jkl1v1n6 wrote:
Now here's how it works: Six simple rules guaranteed to help you diversify, lower risks, level out bull/bear cycles and generate returns that beat the indexes without buying high-expense actively managed funds or wasting your valuable time playing the market.

  1. Market timing is for chumps and chimps. The market's random, irrational and unpredictable. You can't beat it. It loves humbling the mighty. Active trading makes no sense for America's 95 million passive investors, because fees, commissions and taxes kill returns. Besides, Prof. Terrance Odean's research proves: "The more you trade the less you earn." Back in the '90s a chimp throwing darts beat the stock market, made a monkey out of Wall Street. It's easy, you can too.

  2. Perhaps he has never heard of Jim Simons. who in his Medallion fund has averaged 35% returns(after 5% investment fee and 36% profit fee) and the whole idea of the fund is errors in the system. The fund trades thousands of times a day.

troll's picture
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B24 wrote:To me, the bottom line is, regardless of which approach you use, is that you have to execute well.  Any knucklehead can buy an index fund, but it doesn't mean it will turn out well (what if someone bought the SPY in 2000 and held for 10 years?).  However, rotating correctly, the correct basket of index funds did alright the past 10 years.  Conversely, you can compare First Eagle Global to Legg Mason Value, and see that FEG crushed Bill Miller's entry.  So I find it stupid when writers pick arbitrary (or not so arbitrary) funds and indexes to use, as it does not necessarily reflect actual investors results.
However, for the complete novice, just picking a well diversified complement of indexes is probably the least likely to screw you up, so long as you stick to it.
 
One other thing - each of the "Lazy" portfolios above includes a healthy dose of bonds and other asset classes (during the worst 10-year period for equities).  And his actively managed funds are all equity.  So right there it is an incomplete comparison.  If he had compared them from 1995-1999, I bet the result was the exact opposite.  So as someone else mentioned, timing matters.Index annuities have done better than ANY of those strategies.

JackBlack's picture
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Fast Eddie:
Proof please. Please show us the numbers.
JackBlack

troll's picture
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JackBlack wrote:Fast Eddie:
Proof please. Please show us the numbers.
JackBlackIf you care so much, go look it up. I'm not your slave.

B24's picture
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Squash1 wrote:A couple of points. I like b24 says in evaluating the portfolios you are talking about comparing Washing Mutual(The fund invests in stocks that meet strict standards evolving from requirements originally established by the U.S. District Court for the District of Columbia for the investment of trust funds. May not invest in companies that derive their primary revenues from alcohol or tobacco.) and comparing that to the Yale portfolio(with commodities, reits and other alternative classes). Second, There is some validity to the performance of passively managed portfolios. Paul Farrell is a windbag with a deadline to meet. Consequently, his columns on Marketwatch are either about his "Lazy Portfolios" or what doom and gloom we are headed for. Farrell is always short on data. His columns back in the late 1990's, you would have read columns glorifying tech-heavy growth investing. How did that turn out. However I disagree with Anonymous' data because lets face it retirees don't have don't have 57 years(2009-1952) to find out if that happens again(and not take income from it). Although he maybe be right about the numbers they don't really apply. I love how these articles always take famous(or infamous funds) that no one should use and have them be the bench mark and most are based on large cap growth funds. but then compare those results to vanguard's whole portfolio of funds(real estate, int'l, bonds, commodities). Next thing you know DFA will come back into the mix.
 
To bring it to an even simpler form, I took a quick look at the portfolios.  Thay average about 35% fixed income - mostly short term, TIPS, treasuries, etc.  They also contain small caps, emerging markets, etc.  So what he is comparing are COMPLETELY different portfolios.  And what's more, most of the actively managed funds he chose are funds that people only choose because they are in their 401K's (and most 401K's have crummy options).  So it's easy to say "hey just buy cheap indexes and forget about it".  But I could, in 5 minutes, build a portfolio that approximates the weightings in his "Lazy" portfolios that absolutely crushes them.  And if you exclude ONE year's results in the study, the results are completely different.  And if you use the 90's instead of this decade, his portfolios get crushed yet again.
The guy's a big windbag, and one of "them" that convinces ordinary investors that all advisors are bad.

jkl1v1n6's picture
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I went and built two portfolio's, one with all VanGuard funds and one with active managed funds.  I got the active manged funds via Morningstar's Highest Rated.  I had to substitute a couple because they didn't have long enough time frame.
$100,000 invested on 12/31/1997
 
Vanguard Portfolio
Vanguard GNMA - $10,000
Vanguard Short-term Bond Index - $10,000
Vanguard Interm-term Bond Index - $10,000
Vanguard Value Index - $10,000
Vanguard Growth Index - $15,000
Vanguard Mid Cap Growth - $10,000
Vanguard Small Cap Index - $15,000
Vanguard International Value - $10,000
Vanguard Emerging Mkts Stock Index - $10,000
 
Active Portfolio
SunAmerica GNMA - $10,000
PIMCO Low Duration A - $10,000
PIMCO Total Return A - $10,000
Vanguard Long-Term U.S. Treasury - $1  (using Vanguards hypo and they req'd VG fund)
Legg Mason Value C - $10,000
Fidelity Contrafund - $15,000
Hartford Midcap A - $10,000
Baron Growth - $15,000
American Funds Euro-Pac Growth A - $10,000
Dreyfus Emerging Markets A - $10,000
 
Asset allocation is fairly close, within 4% difference
Style box is also within 4-5%
Sectors are as close as I am going to get them.
Regionally within 3% difference
10 yr Std dev is .76 higher in Vanguard
10 yr Mean 1.33 higher in Active
10 yr Sharpe .09 higher in Active
10 yr Alpha .06 higher in Active
10 yr Beta .03 higher in Vanguard
10 yr R-squared 2 higher in Active
 
I'd say for the most part these are pretty similar portfolio's.  I also think they could be two portfolio's that a resonable person could assemble.
 
The difference in ending market value;  Vanguard worth $172,387 and the Active Portfolio worth $202,307. 
 

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The problem arguing investments is that everybody's motive is different (fee based-always get paid regardless of performance, commission-get paid once and never again, % of gains- take more risk to get higher payout, annual fees, no incentive to do anything at all, john bogle- to keep vanguard on top individual investors-blame someone else, day traders- conceal the losses... etc)

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jkl1v1n6 wrote:
I went and built two portfolio's, one with all VanGuard funds and one with active managed funds.  I got the active manged funds via Morningstar's Highest Rated.  I had to substitute a couple because they didn't have long enough time frame.
$100,000 invested on 12/31/1997
 
Vanguard Portfolio
Vanguard GNMA - $10,000
Vanguard Short-term Bond Index - $10,000
Vanguard Interm-term Bond Index - $10,000
Vanguard Value Index - $10,000
Vanguard Growth Index - $15,000
Vanguard Mid Cap Growth - $10,000
Vanguard Small Cap Index - $15,000
Vanguard International Value - $10,000
Vanguard Emerging Mkts Stock Index - $10,000
 
Active Portfolio
SunAmerica GNMA - $10,000
PIMCO Low Duration A - $10,000
PIMCO Total Return A - $10,000
Vanguard Long-Term U.S. Treasury - $1  (using Vanguards hypo and they req'd VG fund)
Legg Mason Value C - $10,000
Fidelity Contrafund - $15,000
Hartford Midcap A - $10,000
Baron Growth - $15,000
American Funds Euro-Pac Growth A - $10,000
Dreyfus Emerging Markets A - $10,000
 
Asset allocation is fairly close, within 4% difference
Style box is also within 4-5%
Sectors are as close as I am going to get them.
Regionally within 3% difference
10 yr Std dev is .76 higher in Vanguard
10 yr Mean 1.33 higher in Active
10 yr Sharpe .09 higher in Active
10 yr Alpha .06 higher in Active
10 yr Beta .03 higher in Vanguard
10 yr R-squared 2 higher in Active
 
I'd say for the most part these are pretty similar portfolio's.  I also think they could be two portfolio's that a resonable person could assemble.
 
The difference in ending market value;  Vanguard worth $172,387 and the Active Portfolio worth $202,307. 
 

 
None of the active vs. passive matters because it is simply measuring past investment performance.   I don't particularly care about future investment performance either.
 
INVESTOR PERFORMANCE counts.  Investment performance means squat unless you are a fund manager.

Squash1's picture
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Forgot about you Fast Eddie.. (insurance guys- aren't smart enough to get licensed use real investments)

BondGuy's picture
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anonymous wrote:Conclusion: Their investors would be better off investing in index funds.

Popular funds
1-year return
3-year annualized return
5-year annualized return

Fidelity Magellan
-33.5%
-9.78%
-3.51%

Dodge & Cox Stock
-29.4
-12.7
-2.82

Legg Mason Value
-28.2
-18.9
-10.4

Ja*** Fund
-25.8
-5.51
-2.02

American Funds Washington Mutual
-25.3
-8.53
-2.32

Baron Growth
-25.2
-7.83
0.54

S&P 500
-26.2
-8.22
-2.24
As of June 30, 2009
Since I have the numbers handy, let's compare the S&P 500 to Washington Mutual.  Washington Mutual was started on 7/31/1952.  A $100,000 investment would now be worth $46,741,187.  The same investment in the S&P would be worth roughly half of that $24,196,677.
 
Conclusion: Index fund investors would be better off investing in active funds.
 
(I think that both conclusions are incorrect and the active vs. passive debate is just plain stupid.)
 
Good stuff! Those reinvested divs sure add up!
 
The active versus passive debate will live on.
 
As will the investment media. Their manifesto "How To Lie With Statistics"
 
 

buyandhold's picture
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iceco1d wrote:jkl1v1n6 wrote:
I went and built two portfolio's, one with all VanGuard funds and one with active managed funds.  I got the active manged funds via Morningstar's Highest Rated. 
 

 
Whoa there cowboy!  Do you realize the fatal flaw in your comparison?!?!
 
You picked the active funds by using Morningstar highest rated?  So you admittedly assembled the active portfolio, by using the funds with the highest historical performance? 
 
Do you realize how unscientific, and how slanted that comparison is?
 
That's like saying, "I'm going to see how good I am at picking football games.  I'm going to go to NFL.com historical stats, and then place bets on the outcomes of games that already happened!"
 
Want a real comparison?  See what the median and mean returns are for those active funds.  See how many active funds, in each asset class, beat the corresponding Vanguard fund.  Then you'll see how much of a chance you have in selecting those "Highest Rated Funds" BEFORE the returns actually happen.
 
All you did was assemble an All Star team at the end of the season...no kidding it should win.  Your ability to assemble an equally effective All Star team 1, 3, 5, and 10 years from now, BEFOREHAND, is nil. 
 
Edit:  Not trying to be a d|ck JK.  I think you're a good dude...but that was just a really bad, biased example.No. The argument is that good managers beat passive management. In the example above, the best managers beat active management. You believe they were just lucky; others believe that good managers have certain characteristics. Using your sports analogy, could I predict an All-Star team 1, 3, 5 and 10 years out. Well, yes I could, or, at least I could make better assessments than somebody picking at random. Many baseball analysts do a very good job predicting what players will do in the coming years. It would get dicier the longer out you go, but baseball talent (like money managing talent) is readily identified.

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I expect that Albert Pujols is going to perform better than the average baseball player over the next 1, 3, and 5 years. 
I can't pick a single fund that I can say that about when we are comparing it to the S&P 500. 
 
I can say that I expect the S&P 500 to outperform the average U.S. Large Cap fund over the next 1, 3, and 5 years. 
 
The fact that the S&P 500 outperforms x% of funds is poor reason to index.  It just means that most funds suck.
 
Maybe we can pick a better fund over a period of time.  Maybe we can't.  It doesn't matter.  If you have a client who is deciding between your recommendation of XYZ and a S&P 500 fund, does it matter what fund does better over the next five years?  No, unless the client is going to put a lump sum down today and not touch it for five years.  If they move it, the 5 year results won't matter.  Even if they they add to it, the five year results won't matter.
 
Ex. 5 years ago, Joe bought Active XYZ.  Sam bought Passive Fund ABC.  They both invested $100,000.  Two years ago, they both invest another $200,000.  Over the last 5 years, Passive Fund averaged 5.2%.  Active XYZ averaged 5.1%.   Who now has more money, Joe or Sam?  How much money do they each have? 

troll's picture
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Passive or active is moot if the client doesn't want what you're selling. 

jkl1v1n6's picture
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Ice, I was hoping you'd chime in here.  Wanted to see where people stood on this issue.  I've now started incorporating both passive and active management into my practice.  It depends on the investor.  Not completely sold on either style personally.
 
What I did is go out and put together a portfolio that a index investor may use and what an advisor may use.  It is reasonable to say that people when constructing a portfolio will go out and pick the best performing funds in the most recent time period.  Yes, advisors are guilty of it also. 
Interesting to note is that the passive mgt strategy is outperforming the active in the 1yr, 3yr, and 5yr periods.  It is lagging the 10 yr. 3.82% to 5.15%. 
I don't think that it's too far off to say that the funds used in the active portfolio might be found in many portfolio's.  Baron Growth, Hartford Midcap, Contrafund, PIMCO funds, Am Funds EuroPac, Legg Mason Value, those are all funds that have a pretty good reputation and have for a while. 
Basically what I see is depending on how those managers perform over the next 5 years will determine if in 5 years everyone will be touting passive management because of the outperfomance over the lagging 10 years. 

anonymous's picture
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"That's a shame.  Because this is no more a debate than whether or not Tylenol is better at relieving headaches than Gas-X.  When you get down to it, there is a clear-cut right & wrong answer."
 
Can you elaborate on this?  I'm asking because I see nothing clear-cut about it.  (passive vs. active and not tylenol vs. Gas-X.)

anonymous's picture
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We'll typically see a claim like, "90% of active funds lag their benchmarks."  A conclusion is then drawn that passive beats active.  I believe that is what you are doing.
I think that other conclusions can be drawn.  The first conclusion is that most funds suck.  Why would we compare against the entire universe of funds when most are not funds that we would ever consider.
 
It would be like saying, "Mario Mendoza (the Mendoza line) was a good hitting shortstop."  After all, he could hit a baseball better than 99% of the people who play baseball.  Why would we look at the entire population of baseball players instead of just the one's who have a track record of being good enough to play in the majors?
 
Let's compare index funds to funds with a long record of success.  When you get rid of the 80% of funds with the highest expenses, an entirely different picture emerges.  What we find is that the best long term performance has nothing to do with Active vs. Passive.  It has everything to do with high cost vs. low cost.   Passive isn't better because it is passive.  Passive tends to do better because it is low cost.  However, there is nothing indicating that passive beats low cost active investing.
 
In fact, use Vanguard as an example.  Their active funds seem to do just as well their passive funds. 
 

"What percentage of active managers lag their true benchmark?"
 
I've never liked that question.  Whenever a manager beats a benchmark, the argument is, "Look how they didn't stay within the benchmark."  Since when is a manager supposed to stay within a benchmark that is determined by someone outside of the fund?
 
I don't have a horse in the active vs. passive debate.  I truly believe that it doesn't matter.  There are so many investing decisions that are more important.

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"Couldn't say it better myself.  If you TRULY could consistently "pick stocks" or "beat the market" (in ANY market or asset class), you most CERTAINLY wouldn't have a job, nor would you share your abilities with clients. 
 
Alas, active managers DO have jobs.  They DO share their "work" with the world.  This should be enough to show you that they don't have that much confidence in their ability to beat the market over time - why should you?
 
And if that doesn't convince you that they KNOW of their own failures...check out what percentage of mutual fund managers actually OWN positions in the funds they run.  It's laughable!
 
Enough for now.  More later.  If you have specific questions, please fire away."
 
I like the comparison, but it's not valid.  Jim is the manager at XYZ fund.  The stated goal of the fund is to beat the S&P 500.   He makes 7 figures a year as the manager.  He has succeeded in this goal.  Over the last 10 years, an investor in his fund would have turned $1,000,000 into $1,000,001.  An investment in the S&P would be worth $846,000  He's done a great job and has been paid very well. 
 
As a fund manager, he very much has his hands tied in terms of what he can or can't do.   It is his income from his job as a fund manager that allows him to invest his personal money the way that would like.  In fact, Jim is very conservative personally and all of his money has gone into EIAs.  He was confident in his ability to beat the market, but not confident that the market would give postive returns. 
 
It doesn't make sense for managers to put money in their own fund unless the money in the fund is invested in the way that they would invest their own money.  That is rarely the case.  The fund's goal and the manager's goal is almost never going to be the same.  

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iceco1d wrote:jkl1v1n6 wrote:
Ice, I was hoping you'd chime in here.  Wanted to see where people stood on this issue.  I've now started incorporating both passive and active management into my practice.  It depends on the investor.  Not completely sold on either style personally.
 
That's a shame.  Because this is no more a debate than whether or not Tylenol is better at relieving headaches than Gas-X.  When you get down to it, there is a clear-cut right & wrong answer.
 
If it were clear-cut there would not be a debate.  Just for the record I am not sold on either style but I am using more passive than active in light of what I have read am starting to believe. 
 
What I did is go out and put together a portfolio that a index investor may use and what an advisor may use.  It is reasonable to say that people when constructing a portfolio will go out and pick the best performing funds in the most recent time period.  Yes, advisors are guilty of it also. 
 
DIY will do that; I would hope an FA wouldn't. 
 
Ummm...The mutual fund industry is counting on advisors doing it.  Why do you think they have wholesalers coming out and showing advisors what's working right now.  
Interesting to note is that the passive mgt strategy is outperforming the active in the 1yr, 3yr, and 5yr periods.  It is lagging the 10 yr. 3.82% to 5.15%. 
This is bass-ackwards from what it should be.  Do the research (didn't I recommend that a year ago?), when you understand why I say this is bass-ackwards, you truly understand the passive vs active issue.
 
It may be bass-ackwars but it is what it is.  I'm quite dense you may need to enlighten me some more. 
 
I don't think that it's too far off to say that the funds used in the active portfolio might be found in many portfolio's.  Baron Growth, Hartford Midcap, Contrafund, PIMCO funds, Am Funds EuroPac, Legg Mason Value, those are all funds that have a pretty good reputation and have for a while. 
 
Really?  I missed the memo here where people admit how GREAT Hartford, Fidelity, American, and Legg Mason funds are!  In fact, they all get ragged on pretty hard on this board.  PIMCO, of course, is excluded from that comment (well, fixed income, anyway).
 
I didn't say the fund companies were great.  You can select specific funds from many companies that perform well.  When I started using Bill Miller 5 years ago he had beaten the S&P for like what, 15 years in a row, he's in the sh*tter now but I doubt people were blasting him then.  This board is much of the time a bitch session.  They blast these funds when clients are losing money and the performance sucks.  Advisors are as guilty as their clients in looking for the next best fund.  Plus the Jonesies get paid when they move from American to Hartford.
 
I reiterate - you just picked the best performing funds of the PAST, and put together a portfolio.  That is EXACTLY what we tell our dipship DIY prospects that they SHOULDNT be doing on eTrade!  ("Mr. Prospect, that's past performance.  You needed to own that fund last year, to get that return...there is nothing saying that fund will be able to repeat that performance over the next X years.").
 
 
Seriously.  Think about how you assembled that portfolio.  Wow.
 
I know that.  That was my intention. 
 
I bet the majority of advisors sell on past performance.  Not just the last year or two but over the last 10 years.  Show me how to pick the best performing funds of the FUTURE and I'm all over it.      
 
Basically what I see is depending on how those managers perform over the next 5 years will determine if in 5 years everyone will be touting passive management because of the outperfomance over the lagging 10 years. 
 
The media touts passive management because it puts them in a favorable light (i.e. "against the guys in the $5,000 suits on Wall St."), that's why whenever a columnist, or media outlet, does a piece on this subject, they butcher it and their argument looks f*cking stupid.
 
No argument there.
 
The everyday investor touts Vanguard and Fido, because that's what they are told by the media.
 
People are sheep, they will follow.
 
The academic world touts ETFs & index funds because the argument is correct.  The research is out there validating every point I've made, excluding baseball. 
 
It's amazing to me, that when the sh*t hit the fan last year, many of you/us couldn't stand waiting for Nouriel Roubini's next insight - hell, probably some of you got a subscription to RGE Monitor! 
 
But yet, you completely glance over the fact, that even this guy admits openly that his ENTIRE retirement nest egg, is in (equity) index funds. 
 
 
Ice, you make great points and very valid arguments.  I have no doubt that you have a much better grasp on Efficient Markets than I do.  You've studied it for years.  I am new to the game and trying to pick it up.  I have yet to find it or understand the definitive research that shows it to be clear-cut.  I am learning to be a self-taught Efficient Markets advisor, you no doubt had PHDs instructing and advising you.  It may take me some more time. 

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Wow, I missed a few posts from when I started my response to you Ice.  Damn clients!  Anyway, I'm on board because in my own research when I factor in all the costs I see little to no real benefit of using active management.  Of course once I tack on my 1% for managing the account it gets closer. 

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Ice,
 
YOU'RE WELCOME!

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Fast Eddie wrote: B24 wrote:
To me, the bottom line is, regardless of which approach you use, is that you have to execute well.  Any knucklehead can buy an index fund, but it doesn't mean it will turn out well (what if someone bought the SPY in 2000 and held for 10 years?).  However, rotating correctly, the correct basket of index funds did alright the past 10 years.  Conversely, you can compare First Eagle Global to Legg Mason Value, and see that FEG crushed Bill Miller's entry.  So I find it stupid when writers pick arbitrary (or not so arbitrary) funds and indexes to use, as it does not necessarily reflect actual investors results.
However, for the complete novice, just picking a well diversified complement of indexes is probably the least likely to screw you up, so long as you stick to it.
 
One other thing - each of the "Lazy" portfolios above includes a healthy dose of bonds and other asset classes (during the worst 10-year period for equities).  And his actively managed funds are all equity.  So right there it is an incomplete comparison.  If he had compared them from 1995-1999, I bet the result was the exact opposite.  So as someone else mentioned, timing matters.Index annuities have done better than ANY of those strategies.
Fast Eddie:

<?: prefix = o ns = "urn:schemas-microsoft-com:office:office" /> 
 
No. that is not the case.
If you had invested $100,000.00 on 01/02/1997 in the S&P Depository Receipts (SPY) and reinvested dividends and capital gains, even with a 1.00% annual fee  your account value would be $209,350.00 on 12/31/2007.
If I had made the same $100,000.00 investment in the Master Dax 5 from allianzlife  you would have $171,460.00
 

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Jack, is there a reason why 2008 isn't included?

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The Master Dex 5 has a 10 year surrender charge.
<?: prefix = o ns = "urn:schemas-microsoft-com:office:office" /> 
 

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jkl,If you wanted to do a true portfolio comparison of active vs. passive go back 5, 10, 15 or whatever the time frame was for the comparison, and then choose the best performing funds at that time. That would more closely model the way most DIYers do their investing. When you retroactively look back at what the best performing funds are in hindsight that gives you an unfair advantage - I think this is what ice was trying to say. Also, there are asset classes such as small caps, international, managed futures, emerging markets that are less efficient by nature and if you do the same comparison, a majority of active managers (or at least a better percentage than large-cap) will beat their passive counterparts. So it's important to look at the efficiency question when making the active vs. passive decision.  This, by the way, was insight ice had on other threads that I thought was applicable here.One thing I have been looking more into is enhanced indexes, ie passively managed investing that takes an index and then screens for forward looking fundamental criteria and  seeks to eliminate the "losers" from the index. This is available in some etf and UIT strategies. The thought behind this is to remove human error and some of the high costs while also generating alpha. Anybody have success/experience with this?

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Has anyone seen this - article in Kiplinger referred to it:http://www.morningstar.com/goto/fundspyI thought the part which tells you how much fund managers had invested was particularly useful if you want to unsell what's in someone's portfolio. Actually, most of the criteria could be used to unsell, if appropriate. Wouldn't use it to choose a fund though.

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One of the thigns we are missing is the active style of management we aer looking at.  It is my opinion that true "style box" managers do not do well against benchmarks.  However, you take "world allocation" funds (as Morningstar would call them), AKA "Go Anywhere Funds", adn they do a much better job in many cases at achieving investment objectives, versus beating arbitrary indexes.  Point being, I am not enamoured by a Large Cap Domestic Growth Fund that beat it's index last eyar, but lost 38% (I am just grabbing numbers).  You could use funds like First Eagle Global, Mutual Discovery, Blackrock Global Allocation, IVY Asset Strategy, or Capital Income Builder (yes, it blew last year), and pair it with something like PIMCO Total Return, and achieve some real goals.  Yes, this is a VERY simple portfolio, but none of these funds are one-hit wonders.  These are classics that are trying to achieve total return, not beat some arbitrary index.  In fact, it is almost impossible to stack it up against a portfolio of indexes, as the allocations change, and some of them use some ecclectic asset classes that aren't picked up by Morningstar, or distort the overall mix (commodities, gold, long/short, etc.).  But in this case, you REALLY have to trust the managers, because they can go anywhere (some more than others).
 
So, my point is that there are two ways to skin the cat (actually three) - indexing, active style-box approach, and active "core/satellite/absolute return" approach.
 
Oh, then there's Index Annuities.

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There is only one way to guarantee a client that they will have more money.

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B24 - I followed you until the absolute return part. It's news to me if these global allocation funds (which do have the advantage of flexibility) are considered true "absolute return" funds. Capital Income Builder, for example, is long-only that I'm aware of. They may employ some absolute return like strategies (such as global rotation) but as far as I know, they don't have the ability to go all cash or bonds like an absolute return strategy might call for.

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Howie, you are correct.  CIB is the least flexible of all of them.  I use that for a more "traditional" balanced approach.  And you are correct, they are not strict "absolute return" funds.  My point really was that there are several great funds out there that are not trying to beat arbitrary indexes, but rather staying positive through all market cycles (though CIB's objective is actually rising income with secondary growth). 
 
However, some of them do have wide latitude, like IVY Asset Strategy and Mutual Discovery.  But you do need to know the in's and out's of each manager, as each fund's apporach is VERY different.  For example, First Eagle is primarily equity driven with heavy doses of gold (and gold mining stocks).  IVY goes all over the place (long/short/currencies, etc.), CIB is a more traditional global balanced fund, Mutual Discovery is DEEP global value and is often heavy cash (lots of smokes and beer stock), Blackrock is the most traditional after CIB.

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JackBlack wrote:
The Master Dex 5 has a 10 year surrender charge.
<?: prefix = o ns = "urn:schemas-microsoft-com:office:office" /> 
 
 
Surely you could run an illustration from 1/1/1998 to 12/31/2008, yes?  But then that would blow up your hypothesis. 
 
Quite a quandry there, Jack.

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Asset allocation is 1000 times more important than active v. passive.  In fact, show me a good asset allocator and I would put my money with him with monster expenses as opposed to a low cost, poorly allocated portfolio.

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Asset allocation is the man-made global warming of the investment world.

troll's picture
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Moraen wrote:Asset allocation is the man-made global warming of the investment world.I couldn't agree more.

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Moraen wrote:Asset allocation is the man-made global warming of the investment world.
 
I'm not sure I agree, but a great quote is a great quote!

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Moraen wrote:Asset allocation is the man-made global warming of the investment world.
 
If you truly believe this, you are not doing it correctly.  That is ok though, most advisors don't.  Cap Inc B, BFA, and Inc FofA is not an asset allocation. 

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Fast Eddie wrote: Moraen wrote:Asset allocation is the man-made global warming of the investment world.I couldn't agree more.
 
Are EIA's an asset class?  You could make the argument.  However, asset allocation involves more than one asset class.

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Sam Houston wrote: Moraen wrote:Asset allocation is the man-made global warming of the investment world.
 
If you truly believe this, you are not doing it correctly.  That is ok though, most advisors don't.  Cap Inc B, BFA, and Inc FofA is not an asset allocation. 

Sam, I use individual equities and bonds. The occasional ETF. I believe security selection through fundamental analysis is the best method for investment returns, and the portfolios of my clients prove it.

I use absolutely zero managed funds.

Asset allocation and MPT are a joke. Even registered rep is finally catching on.

http://registeredrep.com/investing/finance-asset-allocation-0701/

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Moraen wrote: Sam Houston wrote: Moraen wrote:Asset allocation is the man-made global warming of the investment world.
 
If you truly believe this, you are not doing it correctly.  That is ok though, most advisors don't.  Cap Inc B, BFA, and Inc FofA is not an asset allocation.  Sam, I use individual equities and bonds. The occasional ETF. I believe security selection through fundamental analysis is the best method for investment returns, and the portfolios of my clients prove it. I use absolutely zero managed funds. Asset allocation and MPT are a joke. Even registered rep is finally catching on. http://registeredrep.com/investing/finance-asset-allocation-0701/[/quote]
 
I'ver heard capitalism is dead also.  230 years of success followed by one year of failure, let's ditch it for something else.  The couterpoint to your argument is simple, have you ever had a fundamentally strong companies stock go down?  Fundamentals are a vital component to investing, however supply and demand ultimately decide a stocks (or bonds) price.

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Sam Houston wrote:Fast Eddie wrote: Moraen wrote:Asset allocation is the man-made global warming of the investment world.I couldn't agree more.
 
Are EIA's an asset class?  You could make the argument.  However, asset allocation involves more than one asset class.Retard, it's not enough to just read. You have to read AND think.

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Fast Eddie wrote: Sam Houston wrote:Fast Eddie wrote: Moraen wrote:Asset allocation is the man-made global warming of the investment world.I couldn't agree more.
 
Are EIA's an asset class?  You could make the argument.  However, asset allocation involves more than one asset class.Retard, it's not enough to just read. You have to read AND think.   
 
I thought we were going to play nice for a while.  Isn't this site for REGISTERED individuals?  RegReps appreciates the income you generate.

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Supply and demand unfortunately are flawed when put to the test.

Also, most stocks have been overvalued for quite some time and the bond market has been flooded with too many issues as everyone takes on more debt. Do you really think looking at the balance sheets of companies and municipalities that taking on more debt meant that it was a good thing, and that they would be unlikely to default.

As for capitalism - 230 years is an eye blink in human history. While I fought for this nation and believe in America (as she used to be), we steadily move towards a more socialist country.

As for your counterpoint - have you ever had a portfolio where you had everything perfectly correlated and then a large macroeconomic downturn affects the entire portfolio. Bonds, stocks, commodities, etc.

My guess if Fast Eddie doesn't really have to worry about it, but then again, we all have different clients.

Fundamentals haven't been strong in a while. Analysts have been looking at balance sheets much like a sixteen year old looks at $2.50 gasoline - they think that is cheap. Those of us who have been around longer know that's simply ridiculous. They are anchored to that price. Analysts were anchored to horrible financials.

If you actually look at the financial statements of most companies, it's easy to spot the companies that are undervalued vs. overvalued. Even Apple (a stock I love) it was obvious that despite their overabundance of cash that there was no way it was a $200 stock. The same with portfolio managers.

In my opinion this is where active management fails. They are anchored to bad analysis.

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Supply and demand unfortunately are flawed when put to the test.

 
 
So a stock can go up when there are more sellers than buyers?  Please elaborate on your theory.  Also, I look forward to your Nobel Prize in Economics lucheon.

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Sam Houston wrote:Fast Eddie wrote: Sam Houston wrote:Fast Eddie wrote: Moraen wrote:Asset allocation is the man-made global warming of the investment world.I couldn't agree more.
 
Are EIA's an asset class?  You could make the argument.  However, asset allocation involves more than one asset class.Retard, it's not enough to just read. You have to read AND think.   
 
I thought we were going to play nice for a while.  Isn't this site for REGISTERED individuals?  RegReps appreciates the income you generate.No, pussy. It's for people over 13. Your buttboy, Brent, isn't registered and he's here. By the way...do you know how gay you sound mentioning how I generate revenue for rrmag, DHK?

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Sorry, it's your own site you can't post on as a non-registered, couldn't make it out of AG Edwards training dufus.  Who's Brent?

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Sam Houston wrote: Supply and demand unfortunately are flawed when put to the test.

 
 
So a stock can go up when there are more sellers than buyers?  Please elaborate on your theory.  Also, I look forward to your Nobel Prize in Economics lucheon.

Sam - you will be invited to the luncheon, not so sure what a lucheon is. Interestingly enough, I just found out I have an additional 36 months of GI Bill left, and I'm throwing the money away if I don't go back and what am going back for - you guessed it - Ph.D in economics.

But I digress. You need to qualify your question. Do you mean, "More shares being sold than bought"? Or do you mean what you said?

Because if you meant what you said the answer is quite simple. Two guys sell 5000 shares a piece. One guy buys 10000. Price goes up.

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Moraen wrote: Sam Houston wrote: Supply and demand unfortunately are flawed when put to the test.

 
 
So a stock can go up when there are more sellers than buyers?  Please elaborate on your theory.  Also, I look forward to your Nobel Prize in Economics lucheon. Sam - you will be invited to the luncheon, not so sure what a lucheon is. Interestingly enough, I just found out I have an additional 36 months of GI Bill left, and I'm throwing the money away if I don't go back and what am going back for - you guessed it - Ph.D in economics. But I digress. You need to qualify your question. Do you mean, "More shares being sold than bought"? Or do you mean what you said? Because if you meant what you said the answer is quite simple. One guy sells 10000 shares. Two guys each by 5000 shares. Price goes up.
 
Actually no.  If 10000 share are for sale, and 10000 shares are bought, the price would be the same.  If however, the two guys each wanted 6000 shares each, then the price would go up.  Why not just answer the question?  You can't.  But for the sake of boredom, if supply is greater than demand for a stock, how does the price go up eliminating any other outside factors?

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