NEW YORK (TheStreet) --The most successful investment strategy in 2013 was passive indexing with broad-based funds such as the SPDR S&P 500 (SPY) and the iShares Core S&P Total US Stock Market ETF (ITOT) notching gains of 30%.
After years of struggling with disappointing returns during the so-called lost decade, passive indexing has offered excellent returns in the last couple of years, and as always the case in markets, the hot strategy is attracting more assets. Investors too often jump into a strategy they have never tried before after that strategy has succeeded.
Passive investing with index funds is absolutely a valid strategy. This isn't an argument for active investing, but rather a warning that indexing -- as with every other valid investment strategy -- has drawbacks that should be understood.
There is an academic argument for indexing, which was recently discussed by well-regarded investment manager and writer Larry Swedroe, who noted that active management "must lose" to passive investing for several reasons.
The first reason cited is that all stocks must be owned by someone, and since we know that the indexers return will equal the market, the remaining active participants must also equal the market in aggregate before fees. Since active investment strategies charge more than passive strategies, active must lag behind in aggregate.
Swedroe goes on to say that if an active investor outperformed because he overweighted the top-performing stocks, then another active investor would have underperformed for underweighting the top-performing stocks in aggregate.
The investment world has too many moving parts for absolutes such as "must lose" to be useful in deciding whether to be a passive investor. In noting that all stocks must be owned by someone, Swedroe implies that investors must own all shares, which is not accurate.