Actively managed mutual funds don't tend to outperform the S&P 500 over the long term, when you account for selection biases (i.e. if you look at a set of mutual funds from a given brokerage, most of them will appear to outperform the index because they've cancelled the ones that didn't; if you actually choose some of those funds, however, they're going to eventually underperform and get cancelled and replaced with a new set of funds).

This selection bias works somewhat like the old sports betting scam:

1. You get 16,000 email addresses from people who want to receive your expert tips to predict NFL games. You send each of them your pick for the Monday Night Football game. You tell 8,000 of them that the home team beats the spread and the other 8,000 that the away team beats the spread. Be sure and include complicated rationales that will seem prophetic after the fact.

2. Of the 8,000 who received the "correct" tip, you send 4,000 of them one pick for Thursday Night Football and 4,000 of them the opposite.

3. Repeat for the Sunday Night game.

4. You now have 2,000 people who think that you can accurately predict who's going to win a football game, because you've done so for three nationally broadcast games in a row, and the odds of that are astronomical! (I mean, they're 1 in 8, but the kind of people who sign up for spammy sports betting tip newsletters aren't necessarily that sharp). Con 10% of them into paying you $50 for your expert tips for the next Monday Night Football game and you've made $10,000 out of 16,000 email addresses and a week's worth of making up shit about football.

(the exception being, with mutual funds, it's the funds themselves that are dropped instead of the poor saps who invested in them).

...

On the one hand, when it comes to active vs. passive investing, you have the Bogleheads and the hardcore efficient-market-hypothesis types who will tell you that every possible rationale you could ever have for ever making an active investment decision is already priced into the market. On the other hand, Warren Buffett spent virtually his entire life overperforming the market. How to reconcile this?

Actually, I think it's entirely possible for active investment to beat the market, but with a LOT of caveats:

1. The market isn't 100% efficient, which is logically equivalent to saying that it's possible for active investment to beat the market. This seems pretty obvious when you put it this way--100% efficiency is fucking magical, it's not a realistic expectation to have of the world--but how efficient is it? 95%? At that point, you're spending a ton of time and effort finding a market opportunity where you can realize a return of $100 instead of $95. That's a lot of work, and if you're smart and diligent enough to make your marginal $5 that way, you're probably smart and diligent enough to make $10 doing real work instead.

2. So let's say you follow your passions, and active investing is it. You work long and hard to find $5 opportunity after $5 opportunity, and nothing else matters to you other than your loved ones, your weekly bridge match, and advocating for tax reform because you think it's ridiculous how low your taxes are. See where I'm going with this? If active investing is hard enough, and lucrative enough, you're not going to go around asking bored salary drones to let you invest their retirement money in exchange for commissions and fees. That's ridiculous. If you know how to beat the market, beat it yourself and keep all the money. In other words, active investing only works if you, personally, are the active investor. It's not a justification for buying mutual funds.

3. So let's imagine that you are literally the single most successful person in the world at active investing. You're a household name, a genius, an "Oracle", you go to the White House and play bridge with Bill Gates and you're in the top ten billionaire list...

...wait, did I say "Bill Gates"? Take another look at that list, while you're at it. If you're really smart, and diligent, and ambitious, and want to get really really rich by working really really hard at it, it turns out actually creating new businesses works out a lot more often than investing in existing ones. Active investing is exactly the kind of field where you would expect massively outsized returns, and yet, once you eliminate out the heirs, heiresses, and developing country oligarchs who ended up with a controlling stake in newly privatized industries through Totally Not Corrupt Processes™, you're a lot more likely to make a huge fortune by getting 2 billion people to use your ad-supported website, selling cheap flat-pack furniture, selling database software to large companies, selling running shoes, or literally doing any other kind of real work.

So, yeah. Active investing can work out for you, but there's no free lunch, and if you have the money to spare and you're willing to put in the work, you might be better off doing something like buying and flipping houses. Sure, you'll spend frightening amounts of spare time covered with sawdust and choking on mold spores, but at least you'll expect that going in.