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!