FINANCIAL TOOL
Passive Investing
Passive investing means choosing a benchmark and simply trying to match its performance.
No bets are taken based on market forecasts. And usually an ETF is used to allow a manager to set this up and maintain it over time. But little trading is actually done unless necessary to stick as close to the benchmark as reasonably possible.
Active investing is the opposite of passive investing.
Active investing includes moments of market bets that stray from the benchmark in order to potentially capture higher returns. But because of the additional need to forecast and strategize, active investing generally costs more than passive investing.
Here’s the problem.
There are varying theories about how efficient the market truly is. Efficiency means that markets properly price assets based on all publicly known information. And the evidence points to the likelihood that this is the normal state of the stock market.
But if markets are efficient, then any attempt to outperform is actually guesswork, just as likely to fail as to succeed.
Combined with a higher fee, that means active investing usually underperforms its passive counterparts!
There are exceptions, but most cases show that passive investing outperforms active investing over the long-run.
But there is a problem with passive investing.
It’s a very rare person indeed that has the nerve to do it!
Even though buying a passively managed ETF is simple in theory, leaving it alone for ten or twenty years is almost unheard of. According to DALBAR’s studies, the average US investor changes their strategy about every 3.5 years. And because the investors themselves are making those active decisions, they still underperform the markets by a significant margin.
So passive investing is simple, but by no means easy!
Almost no one does it, even if they claim to believe in it.
So here’s the thing many people don’t think about. Or if they do think about it, they don’t believe.
Having some relationship to a financial advisor, coach or counselor can actually be one of the most valuable things you can do, above and beyond making the actual investments. Because while the tools are available, it’s rare that an investor can save themselves from their own emotional biases, overconfidence and misunderstandings that lead to significant underperformance over the years.
While passive investing is an easy thing to imagine, it’s not something that almost anyone successfully achieves in the long-run.