Active Vs Passive Investing
Hey! This is a subject that fascinates me, Active Vs Passive Investing, and if you have read or listened to anything by Jack Bogle (Investor) , Burton Malkiel (Economist) or any Academic about investing, you must be asking: Why on Earth would you be an Active investor?
Let’s start defining what Active and Passive Investing means:
An investor who actively research for stocks to add to his portfolio, this type of investor looks for great companies with great stories to add his portfolio with the expectation of a greater reward due to his diligent research and a bit of help from lady luck over the course of many years (even decades).
Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years. – Warren Buffett
An Investor who acknowledges the fact that Investing is a game in which most of DIY investors under-perform the market, therefore, instead of devoting time to picking stocks, they decide to buy a fund that will give him/her the exact same returns of the market. If you can’t beat the market, be the market!
Investing is more an art than a science, and the longer I Invest the more I recognize that in order to be a great investor, you have to know yourself better
- What is your relationship with money?
- How would you react if you see 50% of your portfolio lost in months? And stay like that for more months?
- Would you immediately sell a stock after buying it and watching it go down?
Honestly, this are questions that you should be asking yourself! But anyway, let’s get back to this post subject.
Why should you be a Passive Investor?
The case for Passive Investing was made popular by John Bogle, founder of Vanguard. John recognized that investing was difficult for most of the DIY investors, who by bad timing and emotional decisions, tend to buy High and sell Low. After many studies he concluded that the “safest” way to invest would be to simply buy the entire market and get the return of the market for a low fee. The problem was that in those days, you had to actually buy all the stocks by yourself which is impossible!
So he created the first Index Fund, the idea is very simple, you just have to buy different index funds like the SP500, Emerging Markets, NASDAQ100, Bonds, etc, and you will instantly diversify your portfolio and get the entire performance of the market, not a percentage more or less, and the best part? You will pay less than 0.5% in fees to do this! Say goodbye to under-performance!
Index funds eliminate the risks of individual stocks, market sectors, and manager selection. Only stock market risk remains. – John Bogle
So, this is the coach potato approach, this is the perfect approach for you if:
- You are fairly new to investing in the stock market
- You don’t want to spend time researching stocks
- You prefer someone else taking care of your investments
- You want a set and forget approach to your investments.
If you answered “YES!” to any of those questions, you my friend, you are a Passive Investor, you will do better by buying a diversified portfolio of Indexes with really low fees, you could do this with a robo-investor like Wealthsimple. The only decision you have to take is: what type of portfolio you want and how much would you like to deposit. That’s it! Check back in a couple years and watch your money grow!
Why should you be an Active Investor?
I must say that picking stocks is not for everyone, this is not a bad thing, again, you have to know yourself. I am an Active Investor because I love the mental challenge of analyzing stocks, going through financial reports, reading the company profile, understanding the business and it’s competitors, and after doing all this homework, buying the stock and watch it grow (or bust!).
If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards. – Peter Lynch
Yes, I’m a geek, I actually enjoy spending hours going through stocks and finding new ideas. If you don’t like this, then you are definitely not an Active Investor. There’s no shame on it, actually, it’s admirable when one can do this introspection and acknowledge that “Hey, actually, I don’t like this, I’m a Passive Investor”.
Being a Active Investor is NOT about buying stocks to trade them the next day, week or month, is about buying companies (stocks) that one find strong, with a great story and fundamentals and that one is so comfortable with it that you are willing to hold the stock for +5 years! Yes, that should be your time-frame when you are picking stocks, if you can’t hold a stock for 3 months, then move to the next one!
One of the most important thing that you have to remember as an active investor is to pay attention to fees, you have to keep your fees low, usually under 1% of your portfolio, if you are paying too much in fees, even if you have big winning stocks, the fees will eat your profit. This is why you want to spend a lot of time researching and next to nothing on the buying/selling part of stocks.
What do successful active investors have in common?
The most successful investors like Warren Buffett, Charlie Munger, Peter Lynch, John Bogle and many other legendary ones, have one thing in common, they enjoy the challenge of picking stocks and they spend time reading and learning more day to day reading books, or in my case, audiobooks :D.
In order to be a successful active investor, you have to read a lot, learn from your mistakes and develop a strategy and stick to it through thick and thin, but most importantly, act according to the fundamentals!
If fundamentals get worst, I get out. If fundamentals get better, I get in! – Mark Schmehl
The second thing that active investors have in common is that they don’t let their emotions dictate their decisions. They have learned about how they react under stressful situations, losing big money, market crashes and everything that you can imagine. By knowing how they react, they can develop a step-by-step course of action on how to act when everything goes south. Instead, the average investor goes into full panic mode and sell their stocks at a loss!
If you want to know what you should on a Stock Market Crash, you should read this post with 5 things to do during a stock market crash
If your emotional abilities aren’t in hand, if you don’t have self-awareness, if you are not able to manage your distressing emotions, if you can’t have empathy and have effective relationships, then no matter how smart you are, you are not going to get very far. -Daniel Goleman
What are the fundamentals you may ask?
Very simple, the company story and the financial results. If a company have a strategy to increase revenue by selling a new product, and quarter to quarter the financials get better, it means that the fundamentals are getting better. But if the company says that they are going to increase revenue by selling a product, but instead, they go deep in debt, burn cash, sales don’t increase, then the fundamentals are getting worse, the story is not aligning with the financials and you should evaluate getting rid of the stock.
Keep in mind that stories takes time to unfold, you might hold a stock for 2 or 3 years before it starts growing out of control, and once that starts, it can keep doing that for several years, 10 or more, but if you are too quick to jump from stock to stock then you will always miss the big gains.
The typical big winner in the Lynch portfolio generally takes three to ten years to play out. – Peter Lynch
If you like this post and you are interested in dipping your toes into Active Investing, I recommend that you start reading these posts:
Thank you so much for stopping by! See you on another post!