Active Investors are Silly People, Part XXXIV in a Series

Most provocative financial research I have read in ages goes to Ken French’s much-discussed working paper, available as of today at SSRN, on the costs of active investing.

How much do investors spend trying to beat the market? I compare the fees, expenses, and trading costs paid to invest in the U.S. stock market with an estimate of what would be paid if everyone invested passively. Averaging over 1980 to 2006, I find investors spend 0.67% of the aggregate value of the market each year searching for superior returns. If the expected real return on U.S. equity is roughly 6.7% and we assume these costs will not continue to grow with the market, society’s capitalized cost of price discovery is about 10% of the current market cap. Under reasonable assumptions, the typical investor would increase his average annual return by 67 basis points over the 1980 to 2006 period if he switched to a passive market portfolio. [Emphasis mine]

Read the whole thing.


  1. Great, all this proves is that the *average* investor spends 10% on the cost of pricing discovery. There has to be *some* cost of price discovery, how else would the markets determine price?
    That average is some distribution around a bell curve. Half of all investors can beat the average return. Obviously we all think we are smarter/luckier than the average so we continue to play the market. In the meantime we keep investor newsletter and blog authors alive! :-)

  2. Exactly. This averages stuff is nonsense. Not that I know he’s right or wrong. But he should show us the curve not some friggin average.

  3. An interesting thought experiment is to consider what would happen if everyone decided one day to become passive investors. Would the market be nearly as efficient as it is without so many resources going into valuation and prediction?
    Maybe a successful market requires gold prospectors so that the rest of us know where to dig.

  4. if you are going to just beat the market why bother doing anything but index. if you are trying to trounce it, and have a strategy, than anything goes and this sounds cheap.
    fish on!!!!!!!!!

  5. i bet u ten bucks pk that if u check this guys cv he has every degree that he can fit up his ass while having spent precisely zero time trading real money…

  6. Paul Kedrosky says:

    Hey Phil
    Sadly, you’d be wrong. Or at least fairly wrong. French is currently a board member at Dimensional Fund Advisors (DFA), one of the largest and most successful fund firms in the world these days. Granted, he’s not trading himself, but he’s also not one of those that-dollar-you-see-on-the-sidewalk-isn’t-there, over-orthodox, Chicago-style economists either.

  7. fair enough pk but i did write “trading”…
    experience,learning.. constructively observing those about u is the thing pk… those who buy when everyone else is selling for ex vs well everyone else… while prospect theoretic irrational behavior is genetic or ‘dispositional’ (as shefrin and statman called it) great traders have trained themselves, as the ballet dancer trains herself to dance en pointe (against the human disposition to walk heel-toe, to market behave counter to instinctual loss aversion…
    nonetheless i call this bet a push in deference to u… bc the guy sits on a board…