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Passive Investing – How’s it different from Active Investing?

What is Passive Investing?

Passive investing has the following characteristics

Advocates Buy and Hold

Generally, uses ETF’s and Mutual Funds

Prefers Index Investing (S&P 500 or Total Market).

Makes no attempt to time the market or outperform it

Seeks to minimize Taxes and Fees

Buy and Hold is when you buy a stock and don’t intend to sell it for a decade or more. In other words, long-term thinking. Yes, you CAN passively invest in individual stocks. For example, I bought General Mills stock in 2017 and I’ve held it ever since. However, people tend to think TOTAL MARKET ETF’s or S&P Index funds like SPY when they think passive Investing. That is passive investing in it’s purest form.

Lastly, passive investors believe you can’t accurately time the market. So you buy as soon as you can-you don’t wait, hoping it goes down. To the passive investor, there is no point in trying to beat the market. You only seek to get market returns. They believe one of the few things investors control is fees, so they use a strategy to minimize those.

What are Pros of Passive Investing

  1. Less Tax Consequences
  2. Less Time Consuming (You can have a life for one)
  3. Don’t have to time the market
  4. Little to no research is required.
  5. Can set on auto-pilot
  6. Fewer Fees
  7. Built-in Equity Diversification

If you are interested in a PASSIVE INVESTING strategy, I highly recommend the Boglehead forum .

Boglehead Forum

Boglehead refers to the type of passive investing advocated by John Bogle, who created the first passive index fund and was Vanguard’s CFO in the 70’s. BUY AND HOLD is the mantra.

What are the cons of Passive Investing?

  1. You won’t beat the market-you get market returns.
  2. It’s boring
  3. You MIGHT be forced to invest in companies you don’t want to invest in.
  4. ETF’s and Mutual Funds DO have expense ratios

That’s right, you won’t be able to brag to your friends about how you beat the market that ONE TIME! Yes, Passive investing is boring. If you like reading about stocks & investing, if you enjoy watching tick marks on charts, this approach is more boring than watching paint dry. Lastly, you’ll probably be forced to invest in companies you don’t want to. Maybe you don’t want to invest in Exxon? There are ESG options these days, but even then, you’re limited. It’s a take it or leave it approach.

Please keep in mind, even though you are passively investing, it still has RISKS. You are taking on the MARKET RISK when you passively invest.

I’ll end this section by saying one of the best things about PASSIVE INVESTING in a Mutual Fund is the ability to set it on auto-pilot. You can deposit a portion of your paycheck every month and have Vanguard (or Fidelity) do its thing. You can set it to reinvest any distributions you get from that Mutual Fund. I’ve found this automation of investing adds up in the long-term. My VTSAX at Vanguard has been like this for over 10 years now. Still reaping the rewards!

Please keep in mind, even though you are passively investing, it still has RISKS. You are taking on the MARKET RISK when you passively invest.

What is ACTIVE investing?

Active Investing usually involves the following

  • Timing the market
  • Individual Stocks; however, you can ACTIVELY invest in ETF’s and Mutual Funds
  • Capital Gains Taxes (Long-term or Short-term)
  • Greater Research
  • More Fees
  • Believe you can outperform the market
  • More interesting for those that enjoy reading about stocks

As you can see, you’ll pay more in taxes and it’ll take more of your time. As the old saying goes, time is money. I personally feel like I no longer want to spend the time I used to researching stocks. I’ve went to a more hands-off approach. It gives me more time to blog and do the things I love outside of investing.

One of the biggest cons of active investing is the lack of diversification. You have to buy dozens of stocks to be properly diversified. You’ll need to diversify by size, sector, and more. Not to mention, you’ll need lots of luck!

To be a great active investor, not only takes time, but it also takes knowledge. You’ll want to learn how to read company’s balance sheets, what PE and PEG values are, and even some basic technical analysis like Support and Resistance. In short, you must be dedicated. Even then, the majority of the greatest investors don’t beat the market long-term. Warren Buffet issued challenges to active fund managers, and well, they lost. FACT-The majority of active fund managers under perform the market.

Summary and my final thoughts

Nowhere is it written that you MUST choose one or the other. You can have a buy and hold strategy with the majority of your portfolio while having a small portion for ACTIVE investing. That’s how my own personal portfolio is set up. I can only see myself increasing my passive investments versus my active investments. For the busy body, it’s hard to beat passive investing.

I’ll leave you with this great video that shows what Warren Buffett has to say about it all.

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