Weekend Reading – Passive vs Active Investing Debate

Weekend Reading – Passive vs Active Investing Debate

Hey Everyone,

Welcome to my latest Weekend Reading edition: passive vs. active investing debate.

Before we get into that, here are some of my latest posts:

Dividends are a great part of investors’ total returns but there are many ways shareholder value is created.

Here are 5 stocks I intend and want to buy more of in 2022.

How long might this current stock market correction last? Read on. 

Weekend Reading – Passive vs Active Investing Debate

Earlier this week, I read an interesting post from Justin Bender related to the passive vs active investing debate – essentially rendering it “dead”.

While I would agree with Justin (academic evidence has proven that the majority of “actively managed funds have been underperforming passively managed indexes and funds for years”), it’s also totally impossible to predict how many active investors might be beating the index or not. Certainly, you can compare hedge managers, pension fund managers and so on against index performance, but there is no luck finding out how all individual investors invest to render any active investing approach fully flawed. The dataset is simply too complex to ever get an adequate handle on.

Before I go on, for the record, I like passive investing – very much so. I own a few indexed products.

For many investors, indexed funds provide an opportunity for retail investor like you and me to obtain market-like returns less minuscle money management fees. The primary goal of a passive investor is to match the performance of a particular index vs. outperformance. That is a very reputable investing objective.

But there is more to the passive and active investing debate than just fees.

I believe active investing strategies might benefit some investors in some market climates – as in now – whereby some stocks or some sectors altogether demonstrate value. At the time I write this, the S&P 500 U.S. index is down about 20% for the year to date (YTD). That’s clearly in bear market territory. Alphabet stock is down 26% YTD.

When the market is volatile or correcting, active investing can shine and provide opportunities. In fact, I’ll go further to say many investors might benefit from a hybrid approach to investing (a mix of passive and active strategies) regardless of market conditions since investors might be able to obtain the best of both worlds – passive investing to remain in the market while using active strategies strategically to take advantage of beaten up stocks or sectors.

In my experience, while lower-fees and lower-fee investing products are far better than higher-fee products as a key predictor of investing returns, I would also argue that investors also need to concern themselves with investing factors like risk, the need for returns, liquidity, and their need to trust money management in others, to realize their financial objectives. To say the passive vs. active investing debate is “dead” without context of other important investing considerations is not overly helpful. 

I can appreciate some fund managers, portfolio managers and other academics have some very strong opinions about this topic. I’m sure they won’t agree with my take and they haven’t. I’ve often heard it should be “indexing or else” from some. I’m far more rational. I prefer making realistic, good decisions over perfectly rational decisions since we’re not always rational, perfect human beings. If you happen to be one, good on you!

I believe different people will have different goals and investing is never a cookie-cutter approach. Cash and real estate investing may work very well for some. Investing in GICs beyond pension income might work very well for others.

Maybe don’t take my word for it – from The Psychology of Money:

“…few things matter more with money than understanding your own time horizon and not being persuaded by the actions and behaviors of people playing different games than you are. The main thing I can recommend is going out of your way to identify what game you’re playing.”

If your top priority as an investor is to reduce your fees and trading costs, period, then an all-passive portfolio might make sense for you. However, just remember when it comes the passive vs. active investing debate some of these considerations also matter:

1. Indexing is more active than you think. Look at the TSX. Historically, financial and energy sectors make up almost 50% of the index. That is not only poor sector diversification but history shows the top companies in this index trade top-spots often. Indexing investing is not without flaws or drawbacks friends. You’ll own some stock studs and duds and you’ll pay some money management fees regardless. 

2. There are degrees of active and passive investing. While low-cost investing continues to be a sensible way to invest, as a strong predictor of long-term investing success, I believe investing in low-cost funds alone is definitely not enough. Investing that aligns with your goals, behavioural balance as part of your risk/reward tolerance, and having the wherewithal to get out of your own way to stay invested when calamity surrounds, are also huge factors in wealth-building success. Having a decent, passive mix of stocks and bonds in index funds hardly guarantees investing success. With or without indexed funds, the most successful investors I know are the ones who invest for the long-term, they don’t tinker with their portfolios, they take equity risk within their portfolios, and they have a high, sustained savings rate for investing. Investing discipline, sustained savings, along with some tax efficiency are key investing traits that extend far beyond low-fee funds.

Passive vs Active Investing Debate Summary

When it comes to the passive vs active investing debate I would keep these keys top of mind:

1. Determine your goals – have goals in mind when it comes to the investments that fit into your financial plan. That could be anything from saving and investing for retirement, to buying a home, or saving some money for a well-deserved vacation. Personal finance is personal. The only judgement on your goals should be yours!
2. Determine your balance – investing in the right mix of stocks and bonds based on your investing risk/reward tolerance can be far more important than picking an index fund over an actively managed fund, or vice-versa. Don’t let other people including experts dictate what your comfort for investing risk or style, actually is.
3. Keep your investing costs low – certainly keeping your money management fees low is a great predictor of potential investing success but making money from investments isn’t about predicting the future – since the future is not accurately predictable at all. Low-cost financial products will absolutely help your investment journey. I use them myself. But keeping fees low without other successful investing ingredients is largely useless. 
4. Keep your investing discipline over time – the biggest enemy we have when it comes to investing is the one we face in the mirror. Our emotions including portfolio reactions to market noise can be devastating to the wealth-building process.

The best answer for you when it comes to your money management decisions and investing approach is usually: “it depends”.

Keep that in mind whenever you read any article (including my own) about what and how you should invest.

Further Reading:

Passive and active investing can exist in retirement planning harmony.

Passive and active investing can exist in retirement harmony

More Weekend Reading…

Have you considered building an energy dividend portfolio? Dale Roberts has some ideas. 

Here are seven stocks rewarding shareholders thanks to Dividend Growth Investor. 

I enjoyed Dividend Hawk’s portfolio update – check out his “Portfolio” tab.

I also liked (and continue to like) Andrew Hallam’s articles when he writes for Asset Builder. A recent one: When FIRE Devotees Really Miss the Mark. 

I think the challenge with FIRE is – people don’t really retire early from what I read – they just do something different for some money. Andrew is a good example. Andrew is financially independent but is certainly not retired. I know, I interviewed him recently 🙂

In Andrew’s recent book, Balance, Andrew identified four considerations for a happy and joyful life:

1. Strong relationships with other people
2. Physical and mental health
3. A sense of purpose
4. “Enough money”.

I suspect whatever you desire, working at what you love into your 70s, FIRE at age 45, financial independence in your 50s or otherwise, if you keep those four ingredients in mind you’ll be more fulfilled….

I read in The Globe and Mail recently that Canadians are sitting on about $300 billion in excess savings triggered by the pandemic. That’s a bundle! Did you save money during the pandemic??

Ben Carlson from A Wealth of Common Sense shared his favourite investment strategy for this market climate:

“The best strategy for down markets, up markets and sideways markets for the vast majority of individual investors is to dollar cost average into an index fund or targetdate fund.”

Then again, I also believe buying periodically into some of your favourite dividend stocks in any market can also be boring and beautiful: markets are down, my dividend income up. 

Indexers: continue to hate on dividends as you wish.

April 2022 Dividend Income Update

Save, Invest, Prosper!

As always, check out my Deals page.

Have a great weekend!

Mark