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.