Weekend Reading – Passive vs Active Investing Debate
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:
- 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!
- 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.
- 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.
- 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.
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:
- Strong relationships with other people
- Physical and mental health
- A sense of purpose
- “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.
Save, Invest, Prosper!
As always, check out my Deals page.
Have a great weekend!
My wife & I are mostly passive investors as we are basically buy & hold TSX listed dividend income/growth stocks. We are 100% equities with 16 main holdings and one mid-sized, limited to 5 sectors – banks, utilities, midstream, telcos, REITs. Our portfolio generates way more dividend income than we need for all our expenses so we never have to sell anything and don’t really care about total returns (and obviously don’t like indexing). That’s the passive part.
The minor active part is I keep $100k extra cash for doing short term trades (as a hobby), we add to our existing holdings $5k at a time as the extra divys accumulate, and we sell a holding when the yield drops below 3%. The latter is now very unlikely to happen as over the last few years, we have gone from 28 holdings down to 17.
Love it Don. I suspect we continue to own many of the same stocks together.
“I own many of the same stocks, some examples:
Banks (Royal Bank (RY), TD Bank (TD), and others).
Insurance companies (such as Manulife (MFC)).
Pipeline companies (Enbridge (ENB) and TC Energy (TRP)).
Telecommunications companies (Telus (T)).
Energy companies (Suncor (SU)).
Utilities (Fortis (FTS), Algonquin Power (AQN)).
There are also industrial and material companies in my/our portfolio (like Canadian National Railway (CNR) and Nutrien (NTR)).
Basically, I buy companies that people need.”
Those “TULF” stocks and REITs will continue to serve you well long-term.
Very smart with your holdings, even 20-25 CDN holdings is plenty good for most.
Thanks. I agree we own many of the same companies. The biggest differences are we are only TSX listed Cdn companies and you are more diversified, and you have quite a few more holdings than we do. As I’ve mentioned, our entire holdings consist of an equal book value of the following: (along with a mid-sized position of ZWB)
– banks – BMO.BNS,RY,TD
– utils – AQN,CPX,EMA,FTS
– midstream – ENB,KEY,PPL,TRP
– telcos – BCE.T
– REITs – DIR.UN,NWH.UN
It’s quite interesting that as time goes on our portfolio looks more & more like Henry Mah’s. From what I understand, he owns 12 TSX listed Cdn companies. Our main difference is he doesn’t own ETFs nor REITs.
As both of us always say: “personal finance is personal” but it’s always so interesting to hear about the various strategies.
Ya, as you know, I hold a bit of VTI and XAW which diversifies my portfolio into the U.S. quite a bit. I will probably always own a few low-cost ETFs like that. Canada is different and always has been IMO.
I like your call on those sectors and stocks – quite smart for steady and growing incomg. Yes, personal finance is very personal is a constant refain on my site and so many Canadians caught up in pricey mutual funds could learn a lot from your holdings Don 🙂
I like the hybrid approach, after all I started with RBC mutual funds then went to individual stocks. The majority of my portfolio is in individual Cdn & US stocks but I do have a few mutual funds (series D for less fees) for no fee trading, and etfs to add diversification, like VFV for the US S&P 500 traded in Cdn dollars for the tech/digital stocks etc I don’t hold individually. I have a mutual fund for Small/Mid Cap Cdn Equity (Canoe GOC1304) because I’m not familiar with those companies and it has done amazing over the last 20 yrs. When I first started I would look at the top 10 holdings of popular mutual funds to see what the “professionals” were stock picking…and guess what? I hold most of those individually! I’m a buy and hold, blue chip, dividend investor and I believe in sector diversification. I built my portfolio over time as I had the funds from saving (=dollar cost averaging). I also always hold about 20% cash because that makes me feel comfortable and gives me flexibility (no selling in down times)…is it popular to hold so much cash? No, but it’s my unique decision as a DIY investor. I always pay for an info service to filter the market down…I don’t do in-depth research on my own but rather cross reference what I hear from different sources I trust to make my decisions. I like personal finance and it’s not a burden to me.
Ya, same Donna – nice to hear from you!
Most of my portfolio is individual stocks although slowly buying more XAW in particular to diversify. VFV is a good fund.
“When I first started I would look at the top 10 holdings of popular mutual funds to see what the “professionals” were stock picking…and guess what? I hold most of those individually!”
Ha. Me too 🙂
You’re VERY smart to keep cash as you invest IMO. The sleep-at-night factor + ability to pounce on stocks when they are lower in price is ideal for wealth-building. Kudos.
Great comments on the Passive vs Active concepts and I also detest the index or nothing approach. This closed thinking applies to so many aspects of personal finance such as CPP timing, debt repayment, emergency fund size, diversification, dividend irrelevance, etc… it drives me nuts. Know why you are doing what you are doing and stop comparing yourself to others. Finance is a personal journey and what works for you may not for me.
Never heard of an indexer trying to give back the distributions they may receive through their fund. They have to do something with those distributions which means they make a choice which makes them somewhat active. Even deciding to DRIP is an active choice. LOL
Loved the Psychology of Money – great read.
Ha, yes: “Never heard of an indexer trying to give back the distributions they may receive through their fund.”
I’m far from disliking passive funds (low-cost, diversified, passive funds). I own a few and likely always will. But telling investors as some advisors have they have “no hope” of realizing some of their investing goals (if they don’t use an advisor and don’t use passive funds with or without an advisor, etc.) is just plain silly.
Buying anything Gruff in these markets?
Or just enjoying that juicy dividend income? 🙂
Not buying yet as I’m waiting to start CPP this summer, (I’m taking it early). Plan is to put some of CPP into debt, invest some and spend some on fun things. What’s crazy is that we will make more money retired then working.
Priority will be building up TFSA.
Life is short, eat the cake.
Ha. Love it: “..we will make more money retired then working.” Nice problem to have as a retiree 🙂
TFSA maxed here (both of them), no money to invest except for taxable for CDN dividend paying stocks going there!
Yes, eat the cake indeed.
Good post Mark.
I’m operating along the lines of where you are, with some indexing products, mostly dividend growth stocks. I also have a few sector specific etfs that I think may offer a little more upside in an inflationary and recessionary climate.
Some years I’ve outperformed markets and others under performed but overall happy with the hybrid approach. I have the time and enjoy staying in the game following markets and the economy, to aid with investment decisions.
There is no one right or wrong way to accomplish financial goals, which has been proven by many people.
Very well put: “There is no one right or wrong way to accomplish financial goals, which has been proven by many people.” Will socialize that one!
I should have followed Mark and you to invest in both Canadian DGI stocks and index ETFs at the same time. I was worried I will not have enough income for retirement at the beginning as I was close to retirement and feel not enough time to accumulate. I am getting there right now.
Excellent to read you’re getting to where you want now. I am certain you’re doing an excellent job and will have an incredible retirement lifestyle, and be very secure financially.
I have no doubt you’re getting there and will get there May with 1) a high savings rate for investing and 2) owning many diversified DGI stocks and then 3) using some ETFs to fill-in-the-blanks 🙂 4) Is to keep a healthy amount of cash or bonds or GICs as you wish, but definitely some cash. You’ll be fine with 1-4. !
The debate is far from dead. And I agree it really depends, how long do you plan to invest, what is your investment goal, etc. etc.
I have a clear goal to have stable income and hopefully not too bad a withdraw when the market down. That’s why my RRSP accounts are full of DGI stocks and I certainly actively managed them. I accepted that long term performance my portfolio might be worse than index but that’s OK as long as I achieve my investment goal. Year 2020 my portfolio is lose to index a lot. But this year YTD, with the index down so much, my portfolio has never been in negative return.
The important thing is when one has the individual investment plan, one knows the why and how as much as possible. If it’s a correct plan, stick to it. All the roads lead to Rome, given you don’t always change your way in the middle of it.
I think you’re right.
I have evolved over time to have that same goal of stable and rising income for peace of mind and choices when markets shine or decline. For me its a combination of having dividend paying stocks & etfs, and a decent measure of cash and gics. This is likely to not do as well as 100% equities but maximizing my investment returns and therefore risk is not my goal. As we approach more sources of stable income (OAS, CPP) I continue to raise our equity allocation. I also accept I may under perform a simple index over time, or not.
So far its working very well and providing a comfortable and secure retirement for us.
As always best wishes on your journey.
I hear ya. I’m sure I’ll evolve with time but the combination of having dividend paying stocks & low-cost ETFs like VTI, XAW is very compelling for me to invest in beyond Canada’s borders. I will also have at least 1-years’ worth in case when I enter semi-retiremnent (I will be working in semi-retirement).
It will be interesting if my mix of dividend stocks and ETFs is “enough” money to live off dividends. I mean, I figure if I can do that without CPP or OAS or even my future workplace pension, that’s definitely “enough” money 🙂
I aspire to live/have enough like you Deane and other retirees that comment on this site – you’ve all done so well for yourselves.
You’re well set already and have a bulletproof semi/full retirement plan.
You have been done very well and will continue to do so I believe. You have a clear vision on your goal and achieved them over and beyond for many years. Who cares how the index does in this case?
Evolve is a good word to describe what a investor willing to learn and adjust behave. I think I am also evolving in some way. I focused on AA and DGI investing of the equity part and heavily invested in Canadian equities at the beginning. I have shifted from bonds after I have enough dividends income to cover basic income. Now I think it might be a good time to shift this Canadian bias of my portfolio and get higher percentage investment out of Canada. I plan to buy some index ETF too as now the market down so much index ETFs are approaching a reasonable price.
Thanks very much May. Its true I don’t really care if we’re easily meeting our needs and wants.
Its interesting to look back at how our investing journey has changed and what has worked or not. I was similar to you on my goals but income now has a higher priority. Ultimately I’m still a total return investor because we do not want to live only on dividends or have a need or wish to leave a legacy.
Yes, the international and emerging markets have not done nearly as well as NA, and may offer better value. Of equities we’re around 30% int/US and 70% Canada now. I was about 45/55 respectively.
Ya, I mean, who’s to say you have to index invest at all?
Does a real estate investor making 5% return on his or her rentals need to invest in a U.S. S&P 500 index fund, because they could earn more there? No, of course not. Does the retiree with a government pension after 35-years of work need to invest in XIU? Not if they don’t want to nor need the money.
I really grow tired of the professional community saying it has to be this or that when it comes to investing. I guess if you’re desire is to drum business that makes sense.
I’m down tens of thousands of dollars on paper in my portfolio but I see this time as a great time to buy more stocks. My portfolio could go down much more as well. I’m just staying invested as much as I can and where I have money, I invest more.
Thanks for sharing your thoughts.
One of my biggest takeaways from a leadership course I attended can be summarized as: Do not measure the quality of a decision on the outcome, but on the basis the decision was made. This fits well with me because I’m innately analytical. There will be people who achieve amazing results with active management, but based on the available data, many many more will crash and burn, or just get severely bruised. There will also be a group in the middle who make their trading decisions cautiously. I think this latter group are likely to do as well, and likely better than a pure index investor. This is the group you appear to be in Mark. It doesn’t seem like it’s a bad place to be in my option.
Good points Bob. That fits well with me too, and I agree that’s where Mark finds himself. A good place.
Thanks Deane! 🙂
Thanks Bob. I agree, some will do well with active management and others, not so much. I think the key to investing success usually boils down to savings rate and long-term discipline with any well-thought out plan. Returns are important of course but your savings rate and sticking to a plan you can avoid tinkering with usually matters more in my experience. I would imagine there are very few pure indexers out there who have never owned individuals stocks or other assets. I’m not one of them 🙂
Appreciate your detailed comment – always thinking, aren’t you?!
I am a blended investor, as well. I like the “active” part, as it is my hobby. I like the passive part, for stuff I am not that good at, or dont have the time to research. It works for me. I am not a fan of 2% mutual funds! Great post. Thanks…
I know many investors that like a bit of “active”. Even some indexers like some 5%-10% active. That doesn’t make it wrong nor right. Certainly I’m all for low-cost funds, avoiding trading, being diversified and more but that doesn’t mean it’s picking an all-in-one fund or nothing. Besides, if most folks bought a handful of indexing ETFs, why on earth would you need a financial advisor?
I like index investing bc it is so easy. I can leave it to Vanguard and essentially do nothing. If I hold individual stocks, I would have to keep an eye on the company.
Individual companies can go to zero. My index fund will not. And if it does, no regular active investor will do better anyway.
The main benefit of dividend investing is to allow ppl to hold 100% equities and ignore that by seeing money paid as dividends.
I think Morgan Housel is correct. There is no debate. Everyone is just playing different games.
Good stuff Tina, indexing can be easy but investor behaviour + savings rate trumps all. I would argue someone with a savings rate of 10%, learning about investing via DIY investing in stocks (dividends or not) is likely to do far better than an indexer saving 5% and doing nothing. Some individual companies can go to zero. A basket of individual companies is very unlikely to go to zero. If that happens, indexing is dead anyhow 🙂
Morgan Housel is correct which is why I don’t like hearing index invest or nothing debates. That is incorrect.