After many years of data collection, passively managed index funds have outperformed their actively managed mutual fund counterparts. A large part of that is the significantly lower fees they command. Another big component is that humans (even the “experts”) are often wrong (and make bad decisions when under duress).
Furthermore, study after study shows that those who are less active with investing perform better over time. Even arguably the best investor of all time, Warren Buffett, advocates that amateur investors passively invest.
Why?
Because emotions like fear and excitement are your own worst enemy in investing. They lead to poor snap decisions, short-sighted views, and often doing precisely the opposite of what you should be doing (selling large amounts in moments of fear and buying large amounts in moments of greed).
Most of the financial services industry despises the ascension of passive index investing because it drives investing fees (and their profits) down. They have done everything they can to dissuade it. And in a number of ways they’ve been successful. A surprising 49% of fund assets are still active versus passive, believe it or not. That number is shrinking, but not fast enough.
Some fund providers have reluctantly followed Vanguard’s model because they have had to in order to avoid becoming completely obsolete. And they’ve been grinding their teeth about it the whole way, whining that passive investing is boring, hands-off, and not fun at all.
Readers – learn from my failures and the failures of millions of wannabe stock-picking-savants. As someone who has tried betting on stocks and actively managed mutual funds, I can attest that there is some fun, excitement, and drama. It’s the same kind of fun, excitement, and drama that you get when rolling the dice at your friendly neighborhood casino. Over-active management of investments has a very similar allure to gambling. And often times, it produces similar results. I lost a crapload of money, most investors who go that route do, and you probably will too.
You know what I think is fun and exciting?
- Matching the performance of the market as a whole, and not wishing you had.
- Paying nearly nothing on fund management fees and trades.
- Beating the performance of actively managed funds and your peers who like to bet on stocks and actively managed funds.
- Not getting discouraged from picking losers or poor market timing and quitting investing altogether.
- Sleeping well at night because you have less risk with a diversified investment allocation.
- Watching your investment portfolio and net worth grow to new heights over time, with no effort required.
- Firing your financial advisor, because you’ve learned how to passively invest on your own.
Boring for the win!
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Love boring investing as well! I don’t think investing is supposed to be exciting. It’s supposed to be boring! You’re supposed to put it there and then look at it many years later. You know what won’t be boring…seeing how much money is in there after you’ve done nothing but rebalance it and stick with your plan for many years.
If I want excitement, I’ll hit up the casino.
There are much better ways to entertain yourself than hitting up the casino. ;-)
Boring has been working very well for us too! :)
“Investment” returns average around 10% – “investor” returns average around 3%. Why the difference? It’s often called the behavior gap and is due to actively trading accounts. So much wealth gets destroyed from non-boring investment activities.
Great post! Articles about how boring investments are the best make me so excited.
Being boringly diversified has been working pretty well. Picking an appropriate strategy based on when you’ll need the money and rebalancing your allocation every so often will give you the best chance of investment success. And all the while you should be ignoring all the financial pundits out there who have their own agenda.
What is your allocation of stocks versus bonds?
Such an important post, and so relevant! The WSJ had a great article titled The Dying Business of Picking Stocks (among several other passive investing articles) a few days ago. While you give up the ability to beat the market with a passive index fund, you can at least be sure the market won’t outperform you! Technology is transforming the way we invest. Particularly with robo-advisors taking share from traditional financial advisors and furthering the passive investing trend.
Excellent article, and yes, a very odd comment by the Times money magazine about wanting “excitement when investing”! Active management has certainly priced itself out of the market and denied themselves any USP by chronically underperforming. However, as a prudent investor (someones who doesn’t want excitement!) index funds are not a panacea. Rather, they track index’s and as we all know index’s go down as well as up.
The US market is moving upwards nicely and will continue to do so as economic activity continues to build pace. Investors following a US index is a no-brainer. Unfortunately, at some given point in the future, it will fall back, it always does and an index fund will suddenly be like a millstone around your neck, dragging an investor into the abyss. And as an adviser, having experienced real people with real investments during bear markets, I can assure you, the investment bravado people possessed during a bull market evaporates very, very quickly. As with all investment, you still need a strategy, ‘passive’ included.
The trick with index portfolios is to rebalance regularly. Unfortunately, robo advice is purely an automated risk questionnaire so, I am skeptical that they will be providing this service in an efficient manner, So don’t be lulled by the hyperbole surrounding indexing and keep your eye on your investments.
I enjoyed reading, regards Adrian
How does market timing change with passive investing? Is there an ideal time to buy or sell it do you just let it all sit until retirement? Also, how does dollar cost averaging fit into passive investing? Testing to determine the best way to manage and grow a passive investment strategy over time.
Fees are going down across the industry and rightly so (I say this as someone on the inside of it). I do want to point out though that in terms of active investing, you may need to distinguish between asset classes. In equity, the figures speak for themselves, but I think in fixed income there is far more scope for active managers to distinguish themselves.
Just looking at markets today, we are in the midst of a multi year rate hiking cycle. An index like the Bloomberg Barclays Global Agg has a duration of 7-8 years with large exposures to currencies like EUR, GBP and JPY. Nowadays the US dollar is weak so it’s hard to say what is going to happen, but typically you’d expect US dollar strength and large losses from duration (7-8% for every 100bps increase on the long end of the curve).
Long story short, a manager who allocates on exactly the opposite side of that and then does the same once the very slow trend reverses itself, is likely to have total returns far above the benchmark over the longer term.