Active investing means aiming to get a higher return than the market index, and here’s why Dave Rae isn’t a fan.
We all want to be better than average, it makes us feel smarter. Who hasn’t been enticed by a big glossy ad from a fund manager showing their amazing outperformance over the previous one or three or whatever number of years. It makes you think, “If only I could invest where the smart money is!”
When you give up on active investing, it means you go with the certainty of achieving the market return. It’s not an easy choice because it goes against the idea that if you are smart or invest with the smart guy on your team, you can beat the market.
These are my five reasons to give up on active investing.
1. Avoid the marketing machine and the market noise
“If I have noticed anything over these 60 years on Wall Street, it is that people do not succeed in forecasting what’s going to happen to the stock market.” – Benjamin Graham, 1976
Fund managers and brokers are smart people and they generally have big marketing departments aimed at getting your investing dollars. I’m willing to guess that just about every investor ever has at one time in their life been sucked into investing in the next big stock, fund or investment.
When you give up on active investing here are some questions that will no longer matter:
- What is the outlook/forecast/future for the share market? (which no one can really answer by the way!)
- How will the tension in the Middle East or the economy in US/Ireland/Greece affect my portfolio? (Do you really want to worry about this??)
And if you’re relying on newspapers or magazines for your investing insights – good luck with that. Try keeping track of a few headlines from the business section each day for a couple of weeks – it will do your head in!
2. Focus on what’s important
“An investment in knowledge pays the most interest.” – Benjamin Franklin
One of the big benefits of taking an index approach is that it allows you to focus only on those things you can control. Instead of spending countless hours trying to beat the market or find the next big thing, think about the aspects of your life that deserve your focus.
One of my favourite quotes from a client is from a retiree who said, “I used to look at my portfolio almost every day, now I’m lucky if I look at it once every three months.” Do you really want to be waking up every morning to check the overseas markets and waste away your day watching CNBC or Bloomberg?
3. We are not emotionally wired for active investing
“The neural activity of someone whose investments are making money is indistinguishable from that of someone who is high on cocaine or morphine.” – Jason Zweig, 2007 – Your Money & Your Brain
One of the most interesting areas of study in investing is behavioural economics. While most of the academic research in this field requires a PhD to understand, there are some really useful basic concepts to know about. Herd behaviour is the tendency of individuals to follow the actions of a larger group.
In investing this is best illustrated by buying high and selling low. Think about some of those stocks back during the tech bubble – no earnings, in some cases no product, but they built this momentum that saw their price rise and rise until the bubble popped.
“Most investors, both institutional and individual, will find that the best way to own common stocks (shares) is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) of the great majority of investment professionals.” – Warren Buffett, 1996
With hindsight it is easy to see where you should have invested your money, but that is not much help for the future. A 2013 Vanguard research paper stated the following in relation to the difficulty of picking active managers:
“Looking at the 15-year records of all the actively managed US domestic equity funds that existed at the start of 1998, we find that not only are long-term outperformers rare, accounting for only 18% of those funds, but they also experience numerous and often extended periods of underperformance.”
“The best way in my view is to just buy a low-cost index fund and keep buying it regularly over time.” – Warren Buffett
Index investing is cheap in comparison to an actively managed equity fund where you’ll typically pay around 1 per cent pa. And plenty of these funds promise the world but are really not much more than an index fund in disguise. Dressed up as active in order to charge higher fees! Your ongoing cost can increase to 1.5 per cent pa for more specialist managers and 2 per cent pa or more for hedge funds.
Like anything though, it’s not just about being the cheapest. This should just be one reason, not the only reason.
This is an edited version of an article that originally appeared on Do Well + Good and is republished here with permission. This article contains general information only. This should not be relied on as independent finance or tax advice. If you are after specific professional advice, speak to your registered tax agent/financial advisor or reach out to Dave at Federation Financial Services.