Individual investing is a subject I’m passionate about both professionally and personally. It’s not a subject I bring up very often, but it’s a pretty big part of my life (I studied finance in school and have only ever worked in the industry). When I was actively studying for my CFP (Certified Financial Planner) Certification a few years ago, I felt compelled to write a few posts about personal investing in what I consider to be “layman’s terms.” At the time, I was also working at a wealth management company that provides investment management to individuals much like you, me, our parents, siblings, friends, etc., and operates within the rules of prudent, evidence-based investing. At the time, I never went anywhere with these posts, nor did I share them with anyone. But now I want to share them with you (and I have to say I’m pretty proud of myself for sharing this post because there are some things my 24 year old self wrote that just sound silly now). This first post attempts to introduce (and personalize) the idea of “passive investing,” a guiding principle of my investment philosophy. As always, please feel free to contact me if you have any questions or just want to chat; it would make my day.
Passive Investing & Active Living. Not so much a paradox as it is a way of life, and a good life, too.
Originally written in June of 2011. No edits were made for Laze of Days. Whenever anyone mentions the “master cleanse,” I can’t help but laugh as I remember all the women I know who have tried it, and how every single one of them failed. The gist is this: you combine an array of [gross, unless on food] condiments, such as lemon juice, cayenne pepper and maple syrup, with a bunch of water. The cleanse asks you to satisfy daily hunger pains (basically, you can’t eat) with this elixir until “you overcome the psychological need to eat,” and you “feel a growing sense of control”. Hmm, sounds a little bit cult-esque, right? One of the girls who tried it told me she started hallucinating a few hours in. You can probably imagine what this led to; she binge ate even more that day than she would have otherwise. Fad diets, cleanses, meal plans, etc. remind me too much of what people in the investment world call active management. Market timing, buying what’s “hot,” moving money from stock to stock in order to capture fleeting, industry-specific gains, etc., these are all examples of active management. These investment “techniques” are basically everything aside from passive management: staying put in a highly diversified portfolio of assets with the mindset that the market reflects all known investment information and cannot be beat. There is a lot of evidence that proves the effectiveness and superiority of passive investing for the long run, when compared to active management. Just google it! As an approach, active management is both emotionally and fiscally draining. Watching stocks with the intent to buy or sell at some pre-conceived movement or event is both tedious and expensive. Not only do you spend most of your time worrying over the nitty-gritty details of your investments, you are spending much more money this way by paying more transaction costs, and realizing short term gains. With passive management (or passive investing), you don’t need to jump from industry to industry, or buy and sell because of random market changes because of just that, the market is random. Studies show that the market moves in a completely random manner, no one knows what it will do (enough to profit from it). So, why waste the time and money trying to predict the unforeseeable, when you could be investing in the market, rather than against it. As long as world economies thrive, the market will grow. By investing in a diversified representation of the world market, you can capture this certain growth, you just have to be patient and disciplined. If I’m starting to lose you, don’t worry, here is where I bring it all together. With all of the articles written in support of passive management, it’s shocking how many people still waste their time and money on active management. Maybe it’s the same part of their brain telling them to try that new diet pill. The girl on TV used it, see how good she looks? It has to work! Unfortunately, you’ll probably face similar emotional ups and downs as you realize the weight isn’t dropping as quickly as you hoped it would, or that the suggested number of pills you need to take is costing much more than you anticipated. Honay, if it takes that much effort, it probably won’t work. However, this is not to say that people have never made money by using the active management approach, or never lost weight using fad diets and pills. How else would those people in the commercials have old pictures of themselves 100 pounds heavier? These methods work…because people luck out. It’s like the lottery, someone is bound to win. Find me a weight loss solution, or a new diet that has years of academic research to prove its effectiveness, and maybe I’ll believe what I hear. For now, I’m perfectly happy trusting in what I know works, not what people are saying will work, right now. Once you realize the true effectiveness of following a proven and disciplined approach to either weight loss or investing, it is easier to adjust your life around these principles. If you ditch the yo-yo dieting, and devote your life to something that works, like exercising and eating right, you will have developed certain disciplines to live by. Such as what to eat, and what to avoid if you want to reach your fitness goals. After determining these guidelines, it is pretty easy to alter your outlook on food – in a positive way. You’ll be surprised how quickly your desire for junk food disappears just by knowing that these things will not get you (and have never gotten you) to where you are trying to be. Similar to investing, it might take facing a few losses to realize one investment approach is not working for you. And you will find it easier to understand that there are certain investments that should not be made by a person based on their unique goals. With that knowledge, you will know what investments to avoid, and what investments are suitable for your needs. You’re not going to bake a cake and eat it right before your wedding (you’ll do enough of that during the wedding and honeymoon). Same as how you’re not going to invest all of your money in one, highly speculative stock a few years before retirement, or a few years before you plan to buy your dream car (it doesn’t matter if it’s a Kia or a Mercedes, it will hurt just the same when you realize you can’t afford either). The wiser choice would be a disciplined investment in a diversified portfolio of stocks and bonds at an appropriate risk level based on when you will need the money. If you understand my grand analogy, then hopefully you realize that the timelines and goals you set for your physical well-being are very similar to those that you must set for your investments. When dealing with both of these areas of my life, I am not going to believe something until I know it will work. Unless someone can convince you with actual evidence that a diet or an investment management approach will work for your life and your goals, I would stick to the basics: passive investing, active living. It’s not a paradox – it’s the best way of life.