About 12% of U.S. American women develop cancer over the course of their lifetime. Best in class medical practice recommends regular check-ups from a certain age on. This happens despite the fact that the majority (88%) of women will not contract breast cancer. The precautionary measure appears straight-forward because a cost-benefit analysis reveals the advantages of early detection.
We might expect similar cost-benefit applications among professional investors. However, evidence-based investing is most often used as the major argument for passive and against active investment management. The incorrect conclusion rests on the fact that academic research shows that roughly 75% of active managers fail to demonstrate particular skills or beat their benchmark. The superficial takeaway by many industry professionals is that active management has no value. Hence, they invest nearly 100% passively.
It is clearly the wrong conclusion. Both approaches, active and passive, have an economic justification. The appropriate strategy should be to passively invest unless being able to find the 25% of active managers who have statistically significant skills. Some professional investors have the expertise to distinguish between skill and luck among active managers. Their cost-benefit analysis is skewed towards benefits, which can be passed on to clients. A best-in-class solution combines passive management with active managers that can add value of some form to the passive approach.
Nonetheless, passive management is the most suitable long-term standalone solution for the vast majority of retail investors. It is almost impossible for non-professional investors to navigate through the investment landscape and distinct management skills from luck. They are better off with a globally diversified core portfolio.