Passive Investing vs. Active Investing – What Takes More Guts?

Last Friday, as I watched markets close lower for the 6th week in a row I started to think  to myself who has more guts

  • The person who keeps shoving money into the market regardless of the news out there (passive index investing)

OR

  • The person who ignores history that the tends to increase over time (Active, Individual Stock Investors)

I find it really odd, but people seem to look at each of these options almost as an ideology.  I can find statistics and news articles that try to prove one investing style is better than another, but I am not trying to change anyone’s “investing religion” just asking the question which actually takes more cajones? To do so we will look at a few quick, undeniable logical arguments about both styles.

The Simple Arguments – Passive vs. Active Investing:

Passive Index Investing

For some reason, people see passive index investing as free of risk.  I have no idea why, they must live in the world of “real estate always goes up.”

There is some risk, particularly in the short term, with just throwing money at a particular index month in and month out.  It isn’t hard to find stories about the “lost decade” in America or the “lost decade” in Japan.

S&P 500 INDEX,RTH INDEXSP

Ignoring dividends (which is hard for me to do) if you head to google finance and check out the 10 year return on the S&P 500 it is less than 1%!

Additionally, there is an argument that you have too much diversity.  For example, today (June 12, 2011) there was an announcement that TimberLand was being bought out by VFC and TBL’s share price soared 42% near the opening bell and VFC was up about 11%.  However, the Retail ETF that obviously holds TBL and VFC (and a bunch of other retail stocks) was only up about 2% (at the time this post was written).

Investing in Individual Stocks is Risky

The main problem with Investing in Individual Stocks is the lack of diversity.  When you own the S&P 500 you own a small piece of 500 companies, so if one company goes bankrupt then your entire portfolio is not damaged. However, if you only own a handful of companies, if one goes under, you can screw up years of gains made.

Second, it is expensive!  Since being forced to change brokers I have learned that trading can be really costly and that is money not working for you.

I really wrote this post to hear what everyone else thought on the subject…so please SHARE!

9 Responses to Passive Investing vs. Active Investing – What Takes More Guts?

  1. Fundamentally it is riskier to be an active investor than a passive investor. I think the guts come into play with both approaches though, because controlling your emotions and sticking to your strategy is not easy.

    Passive investors still tinker with their portfolios, shifting weight from stocks to bonds, emerging markets, etc. Rather than sticking to their allocation mix and rebalancing annually they can sometimes succumb to market timing within their asset classes.

    As an active investor (dividend stocks) I look for a blue-chip stock that has a history of increasing their dividends over time and I buy when they are value priced (using a few different metrics to determine value).

  2. I can be a bit of an ideologue with this topic. It’s usually not because I really care to convince someone, but because I feel like a lot of information is purposefully ignored on both “sides.” This is true with a lot of finance topics, not just this one.

    The control freak in me favors active investing over passive investing. There’s just nothing that really makes sense to me about throwing (quite literally) my future into an account and saying “it’ll be good enough.” I’d much rather own a highly-volatile, low-liquidity, small cap stock I spent time researching than a portfolio made up 500 largest companies by market-cap. It just feels far less risky to me.

  3. Passive or active has nothing to do with risk. The market has been very volatile. Some would view it as an opportunity to buy some stocks/mutual funds cheaply. Is that risky? It is a calculated risk! I dollar cost average into the market as it goes up and down. Although I own stocks and mutual funds, I only add to the mutual fund position in this way. Maybe once a year I may add to the stock positions. I think you need to stay with an asset allocation that fits your risk tolerance.

  4. I think it depends on your style and temperament. I am terrible at knowing when to sell. This makes me a better passive investor than active investor. It’s easy for me to keep buying more shares and dollar cost average in.
    It’s a lot harder for me to be an active investor.

  5. I think they both take a certain amount of guts…just in different ways. If you’re investing passively in index funds you’ve got to have the guts to stick to your strategy when you see your friends raking in the cash on a hot stock. On the other hand, you need guts when picking individual stocks too. It can be easy to let your emotions get the best of you when one of your stocks drops suddenly, and you may end up selling at a loss even though your head tells you to hold.

  6. I am definitely the passive investor type. To be completely honest, for me it is less about having “guts” and more about a general lack of knowledge regarding the whole process. So when things are performing badly, I tend to just dig in and hope it gets better! Probably not the wisest course of action (or rather, in-action).

    One of my goals this year was to become more educated about the whole investing process. To date, I have failed miserably at that goal. I’ve zeroed in on the problem though…. I tend to sit down to educate myself late at night, when I’ve already put in a full day at work, then come home to my “other” full time job (single parent) and give a bit of attention to my side job…. by the time I sit down to read my eyes are starting to glaze over as the basics are pretty dry. Its better than ambien for putting me to sleep!

    I think perhaps my new plan will to do some reading in the early morning (after the first cup of coffee takes effect!)

  7. There are studies showing the average investor sees far less than the average market index returns. Dalbar published one excellent study. The typical investor doesn’t have the time or knowledge to be good enough to pick stocks, and nearly all would be better off buying the SPY (S&P ETF) and adjusting the right stock/cash mix for their age.

  8. I think any form of investing takes guts, as it directly impacts your future financial well being – the quality of which also impacts other areas of your life.

    That being said, your question is probably more complex than meets the eye. To boil it all down, I think that despite the risks associated with passive investing, I think that active investing takes more guts. There are more decisions to be made, likely more volatility (not necessarily but likely), and increased transaction costs in terms of money and even time. Sometimes risks can be worth taking.

    I’ve been a passive investor, though I do think that actively investing a certain (relatively) small percentage of my portfolio is something I’m going to pursue more.

Leave a reply


+ 7 = 13