Miles Everson’s Business Builder Daily
Wednesday: The Independent Investor
In English grammar classes, we’re taught that there’s an active voice and a passive voice in writing.
Most of the time, we’re encouraged to write using the active voice as it keeps sentences short and clearer.
But do you know that there’s also active investing and passive investing?
Today, we’ll see if this concept is pretty much similar to the voices that we use in writing.
Keep reading to know the differences as well as the pros and cons of these two types of investing.
Miles Everson
CEO, MBO Partners
Chairman of the Advisory Board, The I Institute
The Independent Investor
Whenever investors think about which securities they should buy, the big debate around active versus passive investing usually comes out.
… but what exactly is “active” and “passive” investing?
Let’s first establish the difference between the two.
Passive investments seek to simply achieve the benchmark of the asset class. It tracks a market-weighted index or portfolio and maximizes returns by minimizing an investor’s buying and selling.
This means if the stock market in the US achieves a 12% return in a year, a passive investment seeks to reach that same 12%.
This type of investment is most common in the equity market, but it is also common in other types of investments such as bonds, commodities, and hedge funds.
On the other hand, active investments involve actively buying and selling assets in the hope of making profits and outperforming a benchmark or index.
An example of an active investor is a hedge fund manager, who constantly monitors the markets and trades when they see an opportunity to make money.
The thing with active investing is that even the world’s greatest investors say that this type of investment is difficult to depend on.
Here’s what Columbia University Professor, Joel Greenblatt, says about how difficult active investing can be:
“Choosing individual stocks without any idea of what you’re looking for is like running through a dynamite factory with a burning match. You may live, but you’re still an idiot.”
See? Even the greatest stock pickers in the world know the challenges of choosing individual securities and stocks.
That is why most millionaires have taken the advice of the giants of investing… especially this one:
“Instead of spending their nights and weekends researching stocks and bonds, they enjoy their time or put more time into their work that they know so well.”
In other words, most wealthy families own stocks through passive investment funds, which are also known as index funds.
These funds don’t try to beat the market; they simply want to ensure the market’s overall returns.
Let’s dive deeper into what Index Fund Investing is all about.
An index fund is a mutual fund or exchange-traded fund designed to follow certain preset rules in order to track a specified basket of underlying investments.
In the words of Warren Buffett, one of the greatest investors of all time,
“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”
If you’d like to consider Buffett’s advice, here are 3 things you need to know about investing in index funds:
- Index funds’ portfolios mirror that of a designated index, aiming to match its performance.
- Over the long term, index funds have generally outperformed other types of mutual funds.
- Other benefits of index funds include low fees, tax advantages (these funds generate less taxable income), and low risk because they’re highly diversified.
To run a passive investment strategy, you only need to buy a fund that buys the biggest 500 firms or the S&P 500.
By buying a fund that buys that list of companies, you get the average returns of the stock market. Aside from that, there is little to no risk to any stock you own because your investment is spread over those 500 companies.
That’s what an index fund does for you as an investor. It enables you to buy stocks in the S&P 500.
But!
Keep in mind as well that the amount of index funds you buy is simply the amount that each asset class requires to fit your personal investment strategy.
If, in some instances, you still want to try active investing, then by all means do so!
However, you have to make sure that the core of your investment portfolio is invested in the best passive funds for you.
This is so that even if you want to attempt to beat the market, your core portfolio is already built and you won’t be risking your family’s future.
Additionally, you can use your passive funds to benchmark against your own stock-picking performance.
Here’s the bottom line:
Your strong desire to do either active or passive investing should be backed by a strong foundation of disciplined investing.
Hope you’ve found this week’s insights interesting and helpful.
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Stay tuned for next Wednesday’s The Independent Investor!
Learn more about How to Capitalize on Bull and Bear Markets to do well in the markets on next week’s The Independent Investor!
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