Why You’re Not An Investor If You Invest This Way

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passive vs active investing

I love reading all things personal finance.  When I came across this article from Barron’s, it really made me think.

 

Barron’s recently interviewed James Montier of the investment management firm, Grantham Mayo van Otterloo.  You may have never heard of this investment firm.  I hadn’t.  But then this quick little blurb caught my eye.  Their founder, Jeremy Grantham, famously predicted the 2000 and 2008 stock market downturns.  

 

I figured if the firm’s founder could foresee the top of the market twice, this article might be worth reading.  So, I delved in, and right off the bat, the first question intrigued me.  It’s a great one that I often think about as well.

 

I thought for fun that I’d try to do something new.  Read as I break down James Montier’s responses and provide my personal commentary, as if I were in the room to offer my insight.

 

Barron’s: Bonds are expensive, stocks are expensive. What’s an asset allocator to do?

 

passive vs active investingMSM:  If you’ve read my blog before, you know that I think timing the market is a big waste of time.  Whether the market is at the very top or very bottom, that shouldn’t deter you from buying.  

 

In my opinion, you should continue buying based on your asset allocation.  For some people, that means having a 60/40 split between stocks and bonds.  Others follow Dave Ramsey’s advice of investing into four buckets of money: Growth, Growth and Income, Aggressive Growth, and International.  While others, such as JL Collins, recommend going with VTSAX.

 

Personally, JL Collins has put together the best argument on asset allocation that I’ve seen.  I definitely encourage you to read his Stock Series if you’re curious to learn why he believes that VTSAX is the preferred investment vehicle.

 

Passive Investing

Montier: Things just don’t add up.  One group has thrown in the towel and says, “If you can’t beat them, join them. I’m just going passive and be damned.”

 

MSM:  Yes, there is a large group who has thrown in the towel and believe active managers can’t beat passive managers.  They advocate not wasting money on these managers’ fees.  

 

Passively managed funds now account for more than 36% of the market, compared to 28% the year before.  Is 8% is a big deal, though?  Well, more than a $1 trillion has shifted from actively managed funds to passively managed funds.  Or think about it this way.  The loss of the lucrative 1% fee of these actively managed funds has resulted in a loss of $10 billion in potential revenue.

 

That is a big deal!!

 

As a comparison, Charles Schwab and TD Ameritrade last year had a combined revenue of $10.7 billion.  You can see why some of the larger brokerage firms are paying close attention.  

 

For that matter, over the last three years, Vanguard has had inflows into their funds of over $800 billion.  The rest of Vanguard’s competitors brought in $97 billion combined.

 

As a result, these brokerage firms are now trying to compete with fees.

 

Montier:  [Passive investing] is a very strange thing to do at this particular point in time.

 

MSM:  Yes, this is a very strange to do (sarcasm).  Actively managed funds have consistently underperformed the market.  Instead of continuing to underperform, investors have moved their money into an investment that will at least generate the same market returns.

 

This seems to be the opposite of strange to me.  In fact, it would be smart to do so.  But what do I know?  I’m not trying to make money off of people while underperforming my benchmarks.

 

An Expensive Market

Montier:  The U.S. market is at its second or third most expensive point in history. So people are saying, “I either don’t understand the world anymore, or I don’t think that valuation matters anymore,” which is a really weird thing to say. You’re giving up the one piece of information that you know helps determine your long-term returns.

 

passive vs active investingMSM:  The market always seems expensive during a bull market.  I still remember looking at Apple in 2009 thinking that $84 for one share was really expensive.  Never mind since then, they did a 7 for 1 split, and each share is now worth $150, or unadjusted for the split, $1,050.  I’d love to go back in time and splurge on some $84 Apple shares.  For that matter, I’d also love go back and dump more money into the market before Trump was elected, since the market has gone up 20% since then.

 

While it’s inevitable that the stock market will eventually come back to earth, nobody knows when.  Although, some people are pretty confident in their guessing abilities.  An example is investor Jim Rogers.  If you haven’t heard of him, you can google him to see how often over the last few years he has predicted an impending recession.  

 

passive vs active investing

 

passive vs active investing

 

passive vs active investing

 

passive vs active investing

 

I think you get the picture.

 

Back to Passive Investing

Montier:  You cannot describe yourself as an investor if you are going passive. You are welcome to call yourself a speculator, but you honestly can’t say you care about expected returns if you are going passive at this time.

 

MSM:  Let’s do a quick look up of the definition of both investor and speculator.  Then you can decide which one of us, the active buyer vs. the passive buyer, fits into which category.

 

spec·u·la·tor

noun

  1. a person who forms a theory or conjecture about a subject without firm evidence.

 

in·ves·tor

noun

  1. a person or organization that puts money into financial schemes, property, etc. with the expectation of achieving a profit.

 

Since actively managed funds as a whole have consistently underperformed the market, I would consider that they themselves are speculators.  Passive buyers, on the other hand, are investors since they have fact-based evidence that passive investing works.

 

Montier:  For those standing against the tide, there are a couple of challenges. One, how much pain can you take? The U.S. has been an incredibly strong market for a number of years, so going passive is classic returns-chasing behavior. How do you manage the pain? Nothing in the precepts of being a value investor tells you about the path or the timing. It just tells you about the final destination. The light at the end of tunnel is that the more that people buy on the basis of market cap, the greater the opportunity for active managers.

 

MSM:  I have a mixed emotions here.  I believe that with the money rapidly leaving actively managed funds for passively managed funds, this will force all but the very best active managers to survive.  

 

resources passive vs active investingThe lesser-performing active managers will be pushed out of the industry, which is honestly a good thing.  For far too long, Wall Street has made money off of people’s ignorance.  With advice accessible for everyone, I believe we will continue to see passive funds squeeze out wealth managers and an increase in robo-advisors, such as Betterment and Personal Capital.  These companies use algorithms to take the human element out of managing other people’s money.

 

So readers, what do you think?  Are you an investor or a speculator?  Do you think actively managed funds are going to do better in the future?  Have you moved over to passive funds?  Share your thoughts below.

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60 Comments

  1. I recently jumped on the Robo Advisor band wagon and have been loving it. I still have some funds with Vanguard but over half of our non-401k investments are with Betterment.

    I think it was Warren Buffet who said “if you think the market is expensive now just wait 20 years.” What amazes me is how many people still try to time the market, pay for A class mutual funds and give away 2%+ every year to their advisor who just dumps their money in a target date fund. I guess yachts are expensive.
    Grant @ Life Prep Couple recently posted…Staying Fit While TravelingMy Profile

    • Hahahha…I love the line “I guess yachts are expensive.” I’ve heard really good things about robo advisors and I definitely need to dabble a bit more to understand the ins and outs a bit more.

  2. He does bring up a very good point. Money invested at the current high valuations will, on average, give you lower returns. This is not really a problem, even taken that into account passive investing is for most people the best way to invest. But it only works with a long time frame. You need to stay IN the market, even in downturns. My worry is that a lot of new investors have chosen the passive index funds because we have had 7 years of the index going up, up, up. Combine that with low fees and the results of this is fantastic. But what will they do when there is a downturn? Will they stay in their index fund or will they pull it out? Because then you actually become an active investor (even if you are using a passive investment product like an index fund) and once again you are trying to time the market. And it is this ‘timing the market’ (and getting it wrong) that causes active funds to underperform the index OVER TIME. We will see at the next downturn but that will probably proof that even with index funds, a lot of people are capable to lose a lot of money …
    financialfreedomsloth recently posted…Special circumstance investing – taking on to much riskMy Profile

    • I have a feeling if history repeats itself that people will pull out of the market towards the bottom and then sit on the sideline until the market has “sufficiently” gone back up to be safe. Which means they miss most of the returns and continue the buying at the top and selling at the bottom mentality.

  3. I’m definitely an investor. Almost all my money is in Vanguard index funds.

    I also have an Asset Allocation plan that I stick to and I rebalance annually. No. Matter. What. The plan has US equities and bonds, international equities and bonds, and a REIT.

    I do make a mechanical, small adjustment to US equity allocation depending on Shiller PE AKA CAPE. That’s the closest thing I come to market timing.
    Mr. Freaky Frugal recently posted…Bank bonus bonanza!My Profile

  4. I’m an investor for sure, and passive too.

    A lot of people don’t think about this, but even if you put money in at the top of the market in 2007, today you would have about 70% higher investment value than when you started. Sure, it was a bumpy ride, but even with the recession the market has treated buy-and-hold investors quite well.
    Brad – MaximizeYourMoney.com recently posted…Don’t Neglect These 4 “Walls” of Budgeting Your MoneyMy Profile

  5. I like how you have the dictionary definitions for a speculator and an investor. Most of our *investments* are in passive funds, but there are a few active funds and an individual company stock or two.

    Personally, I don’t see the value of the robo-advisors for someone willing to spend a little bit of time researching. Perhaps there is some value in the tax loss harvesting. It looks like Grant up above has had a good experience.
    Mr. Need2Save recently posted…You Paid How Much For A Car?My Profile

    • I definitely think if you don’t have the time or energy to look up stocks that it MAY make sense to go the robo advisor route or if you find a money manager that is blowing it out of the water that you trust. Otherwise, I prefer to manage my own money 🙂

  6. Interesting piece, and great way of commenting. Like your style!

    Investing at all time highs is difficult, but only the average is at an all time high. I think his comparison with investors and speculators is a bit strange though. In my view, it has nothing to do with passive or active investing. But more with speculating on a up- or downturn purely based on passed performances (or technical analysis). Instead of doing proper research on a company or fund concerning micro, meso and macro economic trends.

    • Great points that you bring up Divnomics!!! He did seem to confuse the terms and make them a bit difficult to really understand. Hopefully he’d like to clarify what he meant in the future.

  7. This is such an interesting and originAl format for a post! Your answers are great as well.

    I haven’t invested in stocks yet. But having been listened to Dave Ramsey for a while and seeing the success he has achieved so far (granted a lot of his net worth is from real estate), I think I might just take his advice to see how things go. I think I’m taking his advice on real estate as well. Great post!
    Ms. Frugal Asian Finance recently posted…6 Unexpected Benefits Of Personal Finance BloggingMy Profile

    • Thanks for sharing Ms. FAF!!! Dave definitely does a great job when it comes to talking about debt. I would love for him to share what funds he invests in along with his real estate deals. That would definitely be interesting to see.

  8. I don’t think the definition of an investor or speculator is very important when it comes to growing you savings. What’s important is that we act on information that can help us make better decisions and reach our long-term financial goals.

    One thing that I noticed in the investment industry is the correlation between pay and performance. There is none for active managed funds. I am not comfortable paying for service fees when funds are underperforming their benchmarks and charges me more than the fees of an index fund.

    I stopped listening to fund managers’ sales pitch and predictions. I became my own fund manager and get paid for my own performance.
    Leo T. Ly @ isaved5k.com recently posted…How To Make Money The Easy WayMy Profile

    • “I became my own fund manager and get paid for my own performance.” Couldn’t have said it better myself.

      My money was managed from 2009 – 2015 and even though I’ve had it back for two years (this month), I’m still having “ah ha moments” like when I realized that our managers had put a large sum of money in Vanguard funds. I don’t even want to do the math on the fees for that one. I guess it was better than when we realized that 90% of our money was in cash. Even so, it could have been worse, they could still be managing my money.

      • Oh man that’s awful. I feel like some money managers out think themselves and totally miss the boat and unfortunately people are not always paying attention until it’s too late. That definitely happened to my FIL.

    • I love that you became your own fund manager. I’m sure nobody cares more about your money than you either. Great points!!! Thanks as alway for sharing Leo!!!

    • I think with so many varied opinions coming out there that people get frustrated and throw their hands up. Why deal with it? It’s unfortunate that people aren’t getting better advice early on.

  9. I’m a Bogle head and invest mostly in Vanguard index funds. I’m not going to lie though that in this current market with the bull running for so long that I do feel tempted to move some chips off the table. But I’ve been thinking that for the last year or two…and definitely after the election…and I’d be wrong. The market is often irrational and while many may be right, their timing will often be wrong. Just because those experts predicted the crash doesn’t make them right because their timing may have been wrong.
    Andrew@LivingRichCheaply recently posted…What Would Your Younger Self Say to Your Present Self?My Profile

    • I remember thinking after Trump won that the market would go into a free fall based on some of the overnight numbers. When it swung back the next day I was like…that’s clearly why I don’t time the market 🙂

  10. I do both active and passive, but I consider both “investing”. Active investing does have some advantages (e.g., more opportunities for tax-loss harvesting), even if you don’t think you have an edge. Plus it’s fun, but perhaps that’s the gambler / speculator buried deep within me talking 🙂
    Paul recently posted…Talent and Luck Aren’t FriendsMy Profile

    • I definitely agree that it’s way more fun to pick your own stocks but I’ve always viewed the market as legalized gambling. It can be a great rush or a terrible let down.

  11. I most certainly sit on the passive side of the house. Although my Monday post points out I’m no fan of robo-advisors. Ultimately history has shown no one can predict the market in the short to mid term. Long maybe but then how do you define long?
    FullTimeFinance recently posted…Simple Portfolios: 3 to 5 fundsMy Profile

    • Hahahaha…for me long term is 50 years. Anymore than that and I’m never going to be able to reap the rewards. But if I was in a dynasty family like the Kennedys I might think differently 🙂

  12. Watched the legend of John Henry recently. Automation has finally come to investing. I’m deeply amused that financial advisors are the new Luddites chanting against automation.

    In my own field of policing we have predictive algorithms to help reduce crime. Is it stupid to do high visibility enforcement on a certain street at a certain time to prevent crime? I answe with something the Marines taught me “if it’s stupid and it works, it isn’t stupid.”

    Welcome to the modern era, investors. 🙂

    • I always appreciate your insight!!! I am definitely going to have to borrow that line from the Marines b/c I hear all too often how stupid it is that it actually works.

  13. It is hard to explain something to someone who gets paid to not understand what you are explaining. Montier has investing and speculation mixed up. I will stick with my passive portfolio of index funds. Thanks for deconstructing his argument.
    Dave recently posted…I Bought a LemonMy Profile

    • Thanks for stopping by Dave!!! He is definitely incentivized to make sure that his customers don’t ask questions talking over people and making comments that don’t make a ton of sense is in his best interest.

    • It’s getting to the point that you should do the opposite of what Jim Rogers says at this point. It’s kinda sad but I’m sure one of these days he’ll be right and try to tout that he’s still an expert.

  14. Never pay an advisor who doesn’t know what he/she is recommending.
    Also, when interviewing an advisor, interview their assistant. If the assistant won’t do business with them, big, big red flag.
    Be careful with passive investing.
    VFINX – Vanguard’s S&P 500 index fund only averaged 4.39% from January 1, 2000 to December 31, 2016.
    VTSAX only averaged 5.01% during that same 17 year time period.
    Yes, I know most people have more than 17 years to invest. My point is that the stock market doesn’t always have an 8% rate of return.
    If someone is looking to invest for 30 years and started on January 1, 2000 and only invested in VTSAX, what would they have to average for the last 13 years if they only received 5.01% for the first 17 years?
    Answer: 12.04%
    It’s easy to make money with the markets are going up and especially when the stock markets are making all time highs.
    “Only when the tide goes out do you discover who’s been swimming naked.” Warren Buffett
    Andrew Breidenbaugh recently posted…Being On-Time For WorkMy Profile

    • That’s by far my favorite Warren Buffett quote and he has a ton of one liners that I appreciate. I definitely agree a bull market makes a lot of people seem smarter than they are. We’ll see how they do during a bear market.

  15. Love this, Rob. Sounds like the “expert” doesn’t know as much as he thinks he does. I agree with you, especially about how bull markets always feel expensive. I remember way back in the day betting with co-workers on when/if the market would hit 10,000. Many of us thought it was impossible, and if it did happen it would be short-lived. Guess that shows what we knew back then, and it wasn’t much. That’s why we still never count ourselves as experts. 🙂

    • I can’t believe the market just hit 22,000. Definitely seems way higher than I would have ever expected especially with how low it got during the great recession.

  16. Passive is the way to go. No one can time the market. Even Buffett advises passive over active. That must account for something. Like you said, especially with information so readily available to us now, there is no reason you can’t take your own finances into your hands and be successful.
    Dividend Daze recently posted…Dividend Update – July 2017My Profile

  17. I think people see actively-managed funds as being sexier than passive funds and that active funds have great potential (in the very short-term at least). Passive funds are the exact opposite: they’re very boring and vanilla.

    But I love vanilla! Passive funds usually outperform actively-managed funds over the long haul and their expense ratios are lower too.
    Mike Collins recently posted…Is The Costco Membership Fee A Bargain Or A Scam?My Profile

  18. I was active in the beginning (in my younger investing days). The excitement about researching a stock, buying it and feeling proud to own a piece of a company. I still have many of those stocks. But with new inflows, I’m more passive via ETFs and such. The cost is low, performance is stable and dividends are offered as well. I’m still actively deciding which ETFs work best for me too 🙂
    SMM recently posted…How to Deal With Financial RegretsMy Profile

  19. We are investors and I would say more active than passive at least with our non-retirement accounts. For our IRA’s and 401ks those are passive. Our other investment account is where we try to do research and pick stocks that we believe are undervalued compared to the rest of the market. With that being said, I completely agree that trying to time the market is silly, especially if you are a long term investor. If we find a security we like, we typically buy a quarter of our projected position and then built that position out over time, usually over a few months, but sometimes it takes up to a year to fully fund the position. Whenever we add we try to do it when its below our initial basis, but if the stock takes off and we still like the company and the fundamentals we will add some more shares if its up as well. Thanks for the great post!
    Courtney @ Your Average Dough recently posted…Monthly Goals Update: AugustMy Profile

    • Thanks for sharing Courtney!!! I use to buy stocks back in the day and I felt like I was pretty good but time is definitely not on my side to pick the good ones anymore. So I do passive now but I do miss researching and finding perceived deals 🙂

  20. I’m mostly passive, but I do tilt towards lower valuation markets. I also don’t believe in market timing, but I do think that over long periods of time 10+ years, returns will be better if you start from a low valuation, than compared to say if you started at a high point in valuations (based on PE10/Shiller Cape Ratio). So for example, what that means for me is this: I strictly use index funds and their ETF equivalents. I have the bulk of my money in the US “Total Stock Market” and my tilt in allocation is towards International, and even further, into Emerging Markets since the latter two areas have far lower valuations than the US. Thanks for sharing!
    Tim Kim @ Tub of Cash recently posted…Don’t Buy Commodities (i.e. Gold)!My Profile

    • Thanks for sharing Tim!!! I have a friend that does this as well and he’s had good success with it although there are times that he’s second guessed himself and pulled out before he should have. But it can definitely be an effective strategy if done correctly.

  21. I’m a passive investor, have a wealthfront account that consist of ETFs for over a year now and getting very good returns during this bull market period. When the market gets bear, the media will try to persuade investors to sell like in ’08 but the smart way is to hold most of your investments in your portfolio because it will go back up like it always does.
    Kris recently posted…7 Ways to Have a Great Day HikingMy Profile

    • It’s interesting to hear the influence of the media on the market. I think if more people would ignore the media that their overall lives would be much better 🙂

  22. Hehe let’s send this to Montier!!! He totally has an agenda :p
    When Amazon hit all time highs at 368 everyone thought we were in another tech bubble and held back from buying. Timing the market is no bueno (and pretty lazy way to evaluating too) but it’s psychologically so difficult to not do 🙁 I am guilty of this a lot…
    Lily He-Prudhomme recently posted…July 2017 Family Income Report & Budget BreakdownMy Profile

    • Thanks for sharing!!! With Amazon at $1,000 it’s hard to wonder where it’s going to go from here. Definitely hard to hold on with the market doesn’t make a ton of sense 🙂

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