Why You Should Rethink Passive Investing
Passive indexing has long been popular among the smaller investors. But wealthy investors often pursue more active strategies, either with active managers or on their own. After all, they didn’t accumulate their wealth by sitting back and doing what everyone else does, right?
But the evidence against active management is strong, with the most managers failing to beat the index over time. So why do wealthy investors tend to shun a passive approach to managing their money?
Industry thought leader Charley Ellis breaks the question down into is simplest form. Wealthy investors often owe their financial success to their hard efforts. Growing up, they were told to try hard in school and get good grades, and they’ll go to a top college. Early in their careers, they were told that working harder than the next guy will give them a leg up. And wealthy or not, if you’ve got your goals set, the more you try, the harder your effort, the greater your chances of success.
So how can sitting back and being “passive” be the best investment strategy? Like many things within the bizarre world of investing, conventional wisdom gets turned upside down.
Investors who make more moves to position their portfolios often maneuver themselves right out of success. For example, a 2000 study showed that investors who traded the most underperformed the index by over 6% annually. And those who succumb to their emotions often react to market swings at the worst times, as numerous studies have consistently shown. In all cases, their actions, their active behavior, has been shown to lower their performance.
Conversely, long term investors with a disciplined system for making any changes in their portfolios generate relatively better returns. By staying invested through market cycles and by sticking with a rules-based approach for making portfolio changes, they benefit from a “less is more” philosophy. They avoid the self-inflicted mistakes.
As Charley Ellis puts it, they succeed by winning the loser’s game.