George Costanza on investing, part 2

NEW YORK - MAY 19: Actor Jason Alexander attends the signing of copies of his new book "Dad, Are You The Tooth Fairy" at Barnes and Nobles in Rockefeller Plaza on May 19, 2005 in New York City. (Photo by Bryan Bedder/Getty Images) Bryan Bedder

(MoneyWatch) The most common response I received from readers of my prior blog on George Costanza was that they thought the post was going to be about shrinkage -- the episode many consider Seinfeld's best. That response got me thinking. Never one to let a good idea go to waste, here's my version of the shrinkage episode.

Despite the overwhelming body of evidence that the investment strategy most likely to allow you to achieve your financial goals is to use low-cost, passively managed funds, a large majority of individual investors' assets are still in actively managed funds. Moreover, though the percentage of institutional assets invested passively is perhaps triple that of individual investors, the majority of institutional assets are still invested actively. But that gap is changing so rapidly that we may see a reversal before too many more years pass. Why do institutions have so much more of their assets invested passively? The simple answer is that they seem much more aware of the evidence.

Even if the trend is a slow one, as sure as the sun rises in the East, individual investors are following the same path as institutional investors by moving assets away from active strategies. So there's our first link to Seinfeld. The share of investor dollars devoted to active strategies is shrinking.

The second link is that the high costs of active strategies, in terms of expense ratios, trading costs and tax inefficiency, result in shrinkage of returns available to investors. Shrinking investor dollars and returns? Don't blame the pool for these developments; blame the misguided active-investing strategies.

Whether it's the type of shrinkage experienced by George Costanza, or the type experienced by investors in actively managed funds, shrinkage may not only be embarrassing, it can be costly (look at what it cost George).

Image courtesy of Taxbrackets.org.

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    Larry Swedroe is director of research for The BAM Alliance. He has authored or co-authored 13 books, including his most recent, Think, Act, and Invest Like Warren Buffett. His opinions and comments expressed on this site are his own and may not accurately reflect those of the firm.

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