Passive investing has made so many people rich and it will continue to make many people rich. It’s when you make a good bet on an asset then sit on it for the rest of your life or over decades at a time. Doing nothing is a much better investing strategy than attempting to actively trade and make mistakes.
When I first started my “investing” journey, I actually did a lot of day trading of individual stocks. I got taken to the cleaners numerous times and ended up in the negative. That was when I didn’t have a steady income coming in and I thought that a couple thousand dollars wouldn’t make a huge difference.
Therefore, I turned to active trading in order to drive up income. I was wrong in my line of thinking then. The first couple of years is not going to make a huge difference but what matters is that it sets the foundation up for the later years. I have the perfect case to illustrate this point.
So far, I had a total of 2 full time jobs under my belt. I’m on my third one now. In the two jobs that I’ve held down, the companies offered 401k options. The first 401k, I actually invested something close to ~$65,000. It currently has a balance of $122,000. The second 401k, I invested something close to $82,000.
It currently has a balance of $110,000. The first 401k still has a higher balance because it had a longer investing horizon. The effects of compound investing matters significantly. Especially when it comes to passive investing. I’m a huge proponent of it because it’s made me quite wealthy.
And I know it will continue to do so. Time will tell.
What is Passive Investing?
Passive investing is an investment strategy to generate returns by buying and holding assets and/or securities such as stocks, real estate, or bonds. The most common vehicle used for passive investing are index funds. It is a truly passive way to invest because all you really have to do is sit back and relax.
All you have to do is open up your favorite brokerage account and click a few buttons in order to invest. My personal favorite is VOO, the S&P 500 index, though it is not a recommendation to buy the security. There are many other good options for index fund investing, as well.
Real estate is more active than it is passive because it is an operational asset. There is the buying, holding, re-leasing, maintaining, and selling of the property, if need be. Passive investors are generally long term investors with holding horizons of over decades and decades at a time.
So to figure out if something is passive investing or not, truly evaluate the amount of work there needs to be. Some asset classes need more work than others. You may think an asset class is passive investing until you find out it is actually active investing. There is a stark contrast and difference between the two.
Active investing is the worse way to go, between the two. I will go over the two strategies below.
Passive Investing Pros
One pro of passive investing is that you can SMASH that social share button and post to your favorite social media! Your friends could learn all about this awesome investing strategy. It’s personally made me high five figures of profit. I wouldn’t be surprised if it gets to the six figures.
So with that out of the way, let’s get into the concrete pros of it!
1) Almost Guaranteed Way to Make Money
It’s almost guaranteed because nothing is ever guaranteed. In the past, the stock market generally returned between 7-9% annually. That is fantastic and phenomenal returns. Many people try to beat those returns and fail miserably. And for good reason. None of us can predict the future.
Historically, the S&P 500 never returned a negative result over 20 years. Ever. In any 20 year period. Could that change in the future? Absolutely. However, I personally would rather bet on something with a 100% win rate than the alternative. All you have to do is buy and have the emotional resilience to hold throughout time.
That’s what passive investing is. It was especially hard for me when the coronavirus pandemic hit and I lost close to six figures. In a single month. That was almost my entire salary for the year gone in a single month. To say that I was nervous would be an understatement. However, I held through and now I’m stronger than ever.
2) Very Low Fees
Passive investing usually has very low fees. VOO has an expense ratio of 0.03%. That’s about as close to being free as you can get. For every $10,000 you invest, $3 is taken out of it. Which comes out to 25 cents per month. That doesn’t sound like a bad deal to me.
Not only does it outperform most active investors, it’s cheaper while doing it as well. That’s a win-win. Take a good look at the expense ratios of your investments. Some investments actually charged a 1% expense ratio. I have no idea how that is legal and that doesn’t count as theft.
One of my coworkers was looking into that investment option for his daughter. I promptly stopped that from happening. I was a proud personal finance-r that day. Over your lifetime, that 1% is a lot of money that you’re paying the banks, investment advisor, etc.
3) Set it and Forget About It
Another pro of passive investing is that you can just set it and forget about it. Easy. Simple. There’s no more work for you to do and you don’t have to lift another finger to make you money. How great is that? I rarely think about my investments when I’m sleeping and I don’t lose any sleep over it.
It’s so easy to just buy the S&P 500 and then do nothing with it. That leaves me time to do other things such as doing a good job at my day job. Or researching other business opportunities that I can take advantage of. Whatever else you want to do, you can go for it.
You don’t need to look at the latest industry trends and you can remain ignorant on most subjects of the U.S. economy. Even while remaining ignorant, it’s still going to make you money. Not just any money but money that will make a meaningful difference and impact to your life.
Passive Investing Cons
That doesn’t mean that passive investing is the best thing since sliced bread. There are some drawbacks to the strategy which are:
1) Tests Emotions Often
When you’re buying and holding over decades and decades, there’s bound to be wild spikes in one way or another. With those wild spikes, emotions are going to be running high. Passive investing is going to test your emotional mettle more times than you can count.
In 2018, I was feeling so bad when the S&P 500 returned a -5%. The work that I put in was gone just like that. Then not just two years later, the coronavirus crash happened. That decimated my returns even further. Although my emotions were affected, I didn’t do anything with my investments.
However, I would be lying if I haven’t thought of it. The reason why I didn’t let my emotions override my investing decisions is because my brokerage’s UI is very complicated. I don’t understand my brokerage’s UI in terms of when the sale and buying actually happens. Therefore, I didn’t do anything with it.
Hurray for a bad UI!
2) Passive Investing Will Never Beat the Market
You’re not going to over-perform the market because you are betting ON the market. So you may just be sitting by and watch as your friends boast about how they got 50% returns in one year. That’s OK. Those friends usually never talk about their losses but they love to talk about their wins.
However, you can’t ignore the drawbacks. Passive investing is a patience strategy where you are betting on the long term success of America. Which isn’t a bad bet but it’s not going to ever make you better than America. If you want to get there quicker, it’s not the way to go.
There are alternatives to waiting it out and hoping you get rich over time. These alternatives will bring you riches quicker than you’ve ever hoped for. You will have to ignore those if you want to go this route because that’s not the strategy. You will have to learn to be satisfied with market returns.
Active Investing Pros
So then now let’s go over the other side of the coin. Let’s go over the pros of active investing.
1) Feels Like You’re In Control
Active investing allows you to feel like you’re the one in charge. After all, you’re the one making decisions on whether to buy or sell. That makes you feel like you are the one in control. While this benefit isn’t mathematically or logically the best argument, it’s still a benefit.
I mean, it’s your money, don’t you want to be the one in charge of where you feel like it should go? Don’t you want to be the one to give it a good home? With passive investing, you’re not in control. You’re completely at the mercy of Mr. Market and can’t do anything about it because you’re locked in.
Therefore, if you have a dying need to be in control more so than needing to generate market returns, then this is the big appeal with active investing. It makes you feel like you’re the one actually contributing to your financial success instead of depending on someone else to do it for you.
2) Flexibility
With passive investing, you’re in it for the long haul. You’re locked in. With active investing, you can take your money elsewhere if you feel like it. There’s a tremendous amount of flexibility that comes with that. When you’re buying and holding, you have to wait out and withstand the emotional tolls it will put you through.
With active investing, if you can’t take the heat, you can just sell! That flexibility is a positive for your peace of mind. Some hedge funds actually combat this by having a lock-up period in which investors cannot pull out their capital. Then that would defeat the whole purpose of going with active investing in the first place.
The flexibility is what the active investors are after. Therefore, they’re not exposed to external risks and systemic risks such as 9/11 terrorist attacks or the global financial crisis affecting their finances. They can limit their exposure by pulling out and keeping the investment money as cash.
Active Investing Cons
So just as there are pros, there are cons with active investing as well.
1) Expensive
Thomson Reuters pegs the average expense ratio of active investments to be around 1.4%. That is insane! While that may not sound like a lot, it is a lot. It’s compound interest working against you. Just as compound interest allows you to soar to heights unseen, it allows you to be below ground.
It’s not a lot of money in the first year but it works in a leaky bucket schedule. Over decades and decades that 1.4% is going to be worth so much money your head will spin. Over a lifetime, it can actually even add up to millions of dollars, depending on how much you invest.
Take careful look at the expense ratios. Active investing funds are notorious for charging high expense ratios for underperformance. That’s why passive investing wins in this regard because they can be up to 50 times cheaper than active investing funds while still performing better.
2) Will Rarely Beat the Market
Fewer hedge funds beat the market returns than there are hedge funds that beat it. Think about that for a moment. They charge very high expense ratios yet still underperform the market. That seems backwards to me but there are people who willingly give money to these people.
There are firms who do beat the market in some years. Maybe even over decades. However, even then that could be temporary. Just look at Long Term Capital Management. They had a team of mathematical geniuses that failed after outperforming the market consistently over years.
Active investing funds may beat the market in some years. But what matters is do they beat the market over the lifetime? That’s the real question that needs to be answered. Very few, if any funds have been able to. Therefore, this is the biggest con to the active investing strategy.
3) Loss of Time
When you lose money, you don’t just lose money. You lose the time it took for you to lose the money in the first place. Losing money is one thing, losing time is very expensive. You can always make more money but you can’t get back your time. Therefore, you’re losing twice.
The biggest factor in investing is your investing horizon. It’s your allowed time that you have in order to invest that matters the most. Therefore, protect time very carefully. If time, and therefore compound interest, works for you then soon it’s going to take over your salary and replace your day job income.
It’s the most precious commodity you have. Active investing has this as the biggest downside risk to the strategy.
Passive Investing is the Way to Go
Passive investing made so many people rich, is making so many people rich today, and will make so many people rich. Take it from me who’s made between $40,000 – $80,000 over the past five years through investing passively. That’s money that I wouldn’t have had otherwise.
I know it’s going to be my path way to financial freedom as long as I consistently contribute to the S&P 500. I will gladly take advantage of the company matches along with it. This doesn’t even include my HSA money that I’m going to contribute. Don’t do active investing.
I got burned and lost so much money trying to do active investing in college. I estimate I lost close to $25,000 both in money lost and in opportunity cost with the money. If active investing lost me money and passive investing made me money, then it becomes a no-brainer on which strategy to choose.
On top of which, it frees my time up from the nonsense research that’s not really going to help me gain an edge anyway. I have more time to write blog articles for you guys as a result of the strategy. Isn’t that the best thing ever?! In my 401k accounts, I have close to quarter million dollars. In my 401k accounts, alone.
That’s not even including my after-tax brokerage and other accounts that I have. I went through the failures and successes so that you don’t have to. You can save the time yourself and I’m living proof of the difference between the two strategies. It’s up to you whether you want to listen.
