Tip of the Week: Think You’re a Passive Investor? Think Again!
Transcript:
Hey everyone, Derek Merkler here again. In this video, I’m discussing the misconceived notion of “passive” investing. Whether you are new to financial planning and investing or have done plenty of your own research, you’ve likely heard of the concept of passive investing. You may have come across an article explaining it or even run across someone evangelizing it on the internet.
So here is the common definition usually put forth by someone who calls themselves a passive investor: “I’m a passive investor because I only use low-cost index funds or index ETFs for my investments.” Some may add that they use the dollar cost averaging method for their monthly or yearly investment additions. And some may add some trope about how active mutual funds do worse on average than index funds... or that the expenses of mutual fund managers or financial advisors aren’t worth it.
That’s all well and good. No issues with that technique or people who take the DIY approach to investing or personal finance. However, when claiming to be a passive investor, many people like this either don’t know reality… or they are being misleading.
Huh! Is someone challenging the passive investing dogma? Well, not really. I’m just going to explain that most “passive” investors are really active investors masquerading as passive investors.
So let’s start with the concept of passive investing. The definition of the word passive is “accepting or allowing what happens or what others do, without active response or resistance.” Applied to the investing world, that means that one invests in the global investable portfolio and does nothing else. This global investable portfolio is a market cap weighted portfolio of all available investment options. I’ll provide a link to a source and a chart that visually represents this portfolio in the accompanying transcript on my blog at militaryfa.com. In short, it includes world stocks, real estate, corporate bonds, government bonds, commodities, etc. weighted according to their dollar value in relation to other investments. This portfolio does not include private housing, small businesses, human capital, etc.
As an example, this portfolio has about 35% in world stocks, 30% in government bonds from around the world, and 18% in non-government bonds from around the world. Everything else makes up 5% or less in the global portfolio. A truly “passive” investor would own this portfolio.
Any deviation from this global investment portfolio is a form of active investing. Do you own 100% stocks because you believe that those will offer the best long-term return? Then you are an active investor. Do you have a home bias in your investments as most people do? Then you are an active investor. Do you own small cap and mid cap funds that increase their representation in your portfolio beyond the market weighting? Then you are an active investor. Did you choose a small cap ETF that is built with the S&P 600 index instead of the Russell 2000 index. Then you are an active investor.
The reality is that nearly everyone is an active investor… the question is more of degree rather than active versus passive. One can go from as simple only holding the Vanguard Total Stock Market Index Fund all the way to picking each individual stock or using some sort of trend following strategy.
What’s the point of this video? It goes back to that old adage that not making a decision is still a decision. In this case, supposed passive investors are making active investment decisions and they don’t even know it.
Think about that… especially when you come across those evangelists. Finally, in the big scheme of things, many of the decisions and debates in the active versus passive debate are just not that important. Having a plan and executing that plan with consistency has orders of magnitude more importance than picking an investment fund that costs 10 basis points over one that costs 20 basis points.
Thanks for watching. If you like this video, please share it. And if you have any specific questions or if you want to work with me to develop your financial plan, send me a message using the info in the credits. See you next time!