Active Investing is Dead: Why you should leave it to the pros (and fools) and passive invest instead
Active investing is dead. Not for everybody, but by and far, for most of us mere mortals, active investing is going the way of the dodo bird.
I have seen plenty of my own friends actively trade stocks. I have also personally done it. I used to look up to some of my friends for being so savvy and having such a profound ability at trading individual stocks.
Much wow, so impress.
These days though, I am seriously not impressed. I'll tell you why.
I have realized that for the better part of the last decade that we have been in a bull market. Here's the problem then. During a bull market, as long as you follow the crowd, you're going to look like a pro. So, of course, those amateurs (including myself) were able to be active investors.
“The investor’s chief problem—and his worst enemy—is likely to be himself. In the end, how your investments behave is much less important than how you behave.” - Benjamin Graham
Bottom Line Up Front
Being an active investor in any type of investment vehicle without having an excellent grasp is almost always going to result in a less than desirable outcome. If most equity fund managers can’t beat the market, why do so many of us think that we can?
It is important then to thoroughly educate ourselves in a particular investment type if we are to be actively involved. Otherwise, we are best off with passive investments, where our emotions are unable to hamstring us.
Conversely, if we are not well educated or passionate about a particular investment vehicle, passive investing makes for an excellent alternative to carrying too much cash or cash equivalent, as this too carries risk with it, in the form of inflation.
Then read below about realistic and viable options to conduct passive investing. (#5 on the list is my favorite)
Active investing is for (exceptional) professionals
This chart shows why active investing is for professionals, and then not even all of them because as the above chart shows, usually, the majority can't even keep up with the market. And they're "professionals."
I personally invest in real estate. Not exclusively, but just for the sake of the point, I am trying to make. I don’t have an extensive background in it. At the time of this writing, I only own two rental properties.
Nonetheless, there is a huge distinction between my investing in real estate as an investment vehicle versus investing actively in the stock market. I actually know the numbers and I know what I am doing. (For the most part)
With the stock market, I have no clue except for based on recommendations from other people or other sources. I would go based on buy or sell ratings. I would follow the crowd, and you know what Warren Buffet says about crowds?
"Be fearful when others are greedy and greedy when others are fearful." - Warren Buffet
It's called speculation. That's what the vast majority of us are doing. We're speculating.
Just like I had to listen to people blab all about how all the MJ stocks are going to take off and make whoever invests in them wealthy. Speculation.
If somebody or some group told me there is gold in them there hills, and I go panning for gold in "them there hills", that is what we call speculation.
Here’s the dictionary definition: the forming of a theory or conjecture without firm evidence.
Check this out... Warren Buffett reads five to six hours a day reading newspapers and 500 pages of corporate reports.
Okay. If you aren’t doing that, or something even close to that, you have no business being an active trader.
Also, here’s another fun fact, and it is from your boy Warren, once again.
“If you invested in a very low-cost index fund – where you don’t put the money in at one time, but average in over 10 years –you’ll do better than 90% of people who start investing at the same time.”
Here's something else. This is a snippet from the S&P Indices Vs Active or SPIVA's year-end report of 2018. (2019 wasn't released at the time of this writing. Somebody comment in the future and tell me to update it and I will.) I touched on another chart from the same report earlier.
Anyway, check it out.
Look at the portion in the red square. Essentially what that means is over that given time frame of the column, that is the percentage of actively managed funds that have been outperformed by the benchmarks. 🤯
Is that even a real statistic? What are most of us even doing buying and selling stocks? Who are we even kidding?
I imagine that this phenomenon comes from a few things.
There’s the fear of missing out (FOMO) because as the market goes up, people want to jump on that gravy train.
Also, we can compare it to how people are much more comfortable in a car compared to an airplane, even though we’re about 86 times more likely to die in a car than a plane. I suppose it’s a control thing, just like active investing versus passive…
Shouldn't I just hold cash then, since it is safe?
"Ken, if I stash all my duckets under the mattress, there's no risk, right?"
Wrong-o. As long as you want to let your buying power erode due to the long term effects of inflation, then sure.
I promise you, with money, there is always risk involved. Since I mentioned inflation, right off the bat, that is a risk associated with holding too much cash.
For those of you old enough to remember (talking to you, Boomers), the rate of inflation in the United States in 1979 was 11.35%. That's pretty unfortunate. But even more unfortunate was for somebody to hold cash, unprotected from inflation. The buying power of the dollar eroded away that year by that amount. Ouch.
Even more than that, $100 in 1979 was equivalent to the purchasing power of $346.05 in 2018.
More than inflation, there is such a thing called hyperinflation, though that'll be a topic for another day. But just for your entertainment and edification, let me briefly describe it in a humorous fashion.
Here's how I would describe hyperinflation. If inflation were a person, a disreputable person... imagine that this seedy and disreputable "ne'er-do-well" is doing lines of coke.
Yes, hyperinflation is the coked-out version of inflation.
The long story short is that as bad as high inflation rates can be, like the ones we have seen in decades past in the United States, are nothing compared to hyperinflation, which is inflation rates at astronomical amounts...
So, we can't beat the market... we shouldn't hold too much cash... what now?
How should the mere mortal (ameteur) invest then?
If the benchmarks are just about impossible to beat, what do we do then?
If cash still carries risk with it because it slowly erodes away, what are we left with?
There is a balance. Carry enough cash as you must. You need to have an emergency fund, and it should be hedged against inflation as best as possible. An example might be any high-yield savings account that is FDIC or SIPC insured.
That still leaves us with what to invest in, in order to build significant wealth.
I'm going to partially retract what I have been saying for a large part of this article thus far. If you are truly a maniac about investing in corporations, then do it. If you love reading company reports and you spend a lot of your times reading their balance sheets like a crazed masochist, go right ahead. You are probably the right fit for investing in the stock market.
I think though that is solid advice for anybody looking to invest. It makes sense to invest in something that you have done your homework on. You need to be calculating the risks in order to mitigate or avoid them if you can't absorb them, depending on your stage in life.
As I mentioned before, I have read a handful of books about rental real estate investing, and so that is the direction that I am personally going in.
If a close friend or family member has come to you with a presentation, showing their numbers with a potential investment, and they are asking for a private investor and you are looking over their investing strategy, and you have good faith in their work ethic and trustworthiness, that might be something you might want to invest in.
The point is, you should be investing in something that you are either passionate about and/or you know a decent amount about, in order to calculate and mitigate the risks you're taking. I feel like this seems obvious...
What happens though if you don't really have any investment strategy that you are either passionate about or know a good amount about? What do you do?
There are plenty of options for passive investment strategies for people who just don't have whatever that niche that they might be interested in or know enough about that can make them a sizeable return. Still, they have their risks, and that means everybody should do their due diligence in making sure they understand the associated risks. As I said before, with money, there is always risk.
Pure, unadulterated mindless and passive investing
Before I tell you that you should be passive investing, I should mention to you one more time, you should get passionate or highly learned about a particular investment vehicle. But not everybody is passionate about investing, just like not everybody cares about butterflies.
I'm just going to tell it like it is. If there is nothing that you know enough about or care enough about as a means of investing with significant returns, you need to be passive investing.
Don't confuse this with passive income (even though passive income is amazing). Passive investing simply means that you are putting your money into an investment vehicle, and then you set a reminder to check on it a few times a year, or a few times a decade I suppose.
Ok, let's discuss some ways to passively invest.
Note: This is by no means an exhaustive list. You are definitely not here because you googled “best way to passively invest”. Unless I’m ranking higher than The Balance or Investopedia. I’ll just briefly discuss the most common ones, and then talk about my personal favorite.
Robo-advising is probably the latest and greatest when it comes to pure passive investing in stocks and bonds, both in the domestic market and internationally. Essentially, you just put your money into an account at one of these companies (they're all online), and then you answer a few questions that help them understand your risk profile, and they just allocate your money, making constant adjustments based upon the fluctuating market.
There are plenty to choose from. I'm not going to mention them here because let's be honest, I'm not going to beat Nerdwallet in the Google rankings if somebody were to search for that anyway. So just Google "best Robo-advisors".
ETFs are a good option as well. They enable you to diversify and they have low fees. Just be careful though, you can certainly actively trade ETFs just like you could with individual stocks...
I won't lie to you, this one's a simple one. Like Forrest Gump said, "that's all I've got to say about that."
REITs are becoming increasingly popular. Pronounced "reet", a REIT is a Real Estate Investment Trust. For you millennials, that's basically like crowdfunding, except buying some primo real estate.
Companies like Fundrise are hitting it big, they're not exactly a traditional exchange-traded REIT, but they're still regulated by the Security and Exchange Commission. Nonetheless, the returns have been pretty good in the last decade, but so has the real estate market in general...
A big risk with companies like Fundrise is that your money is locked up for a period of time, typically for five years from what I understand. What happens if Fundrise tanks and files for bankruptcy? I'm not going to lie, I looked it up, and I think you might get your money back... but it might take some time. (I got bored after I read some bologna jargon about acronyms.)
#4 Peer to Peer Lending
I have never personally done peer to peer lending. North Carolina is one of those states that you can't... (LendingClub investing map)
Still, for those of you not in those states, this might be a decent option. You can act as the bank, lending other people money.
Just remember that the basic premise is when you are lending money, you will get higher returns for riskier borrowers. That's just how it always is. It might seem enticing to seek the higher returns of a riskier borrower, and sometimes it is. Risk mitigation just needs to be employed.
#5 Promissory Note
I love this option. This is my favorite.
I mentioned this one earlier. Promissory notes. I am a big believer in this one. Basically it is a private note between two people, usually family or close friend, or a business partner potentially.
What this might look like is, say you have a good friend that is constantly buying and flipping houses, or buying a few rental properties a year, trying to hustle. Typically, the barrier to entry is available equity. What that means is, a lot of times they'll be strapped for cash.
There is always a down payment in most situations. It is also beneficial to purchase in cash to avoid some of the costs associated with closing on a real estate purchase.
This is where the private investor comes in. Investing could be as small or as large as you wanted to. You could do a promissory note for $500 if you wanted to. You could do one for $100,000. But the real magic is in the terms of the note. You can do something like a 60-month note, where they pay you 7% a year, interest only. At the end of that term, they give you back whatever amount it was that you let them borrow.
You as the investor don't have to do anything except transfer the money, and then receive the money, plus interest at the end of the term, when the note comes due.
Don't be a hero. If you don't honestly know what you're doing when it comes to your investment strategy, give up the reigns. Get into some sort of investment strategy or vehicle that doesn't allow you to do dumb things like try to time the market or sell off or buy during a market frenzy or panic.
Unless of course, you decide to pigeon hole your expertise. Get really good at something. Learn it inside and out, right-side up and upside down. Then sure, that is definitely the right approach.
And last but not least, please people, don't be holding way too much in cash or cash equivalents. Just hold enough for a rainy day, 3-6 months emergency funds, in an inflation-protected account.
The Woke Hack
"The best-laid plans of mice and men often go awry."
Time to Pay it Forward
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