Passive investing has never been as popular. Not only is it cheaper but there is lots of evidence that most active fund managers do not beat the market over the long term. Warren Buffett in his latest shareholder letter says that when asked for investment tips, he tells people to invest in the S&P 500.
Passive investing means buying into an index and letting capital markets calculate the value of an asset.
Active investors believe they are able to price assets more accurately than the market. They perform research and analysis to arrive at a price for an asset. If the market price is below their calculated price they might buy that asset to make a profit when it rises. But however carefully they make their calculation; it is never more than an estimate upon which they base a prediction. Some estimates will be right; some estimates will be wrong.
We are now seeing passive investors thinking the market is overvalued. Their intention is to shift assets into cash and wait until there is a correction, when they will go back into the market at a cheaper price. Does this sound like passive investing to you? Or is it more like active investing?
When you invest, you are taking a risk with your capital and are therefore entitled to share any financial rewards. But you also have to accept any losses that are suffered. Trying to get all of the upside and none of the downside is something that is impossible to achieve. You may get it right once or twice but that’s just being lucky. The best active managers in the world, with all their resources, cannot avoid downturns on a consistent basis. There is no reason to believe that you can.
If you do try to time to market, what you will find is that you will miss out on some of the biggest gains when the market does recover. No one rings a bell when the market hits the bottom and recovery doesn’t go up in a straight line. There will be ups and downs so you won’t be sure when is the best time to go back into the market. You will be leaving some big gains on the table.
If you take a passive approach to investing, let the market price your assets for you and don’t try to time the market. That is not passive investing.
If you have any questions, send me an email to firstname.lastname@example.org