Passive Investing Exists

Many people like to say that passive investing doesn’t exist.  However, these people make a living from active forms of investing and are just playing semantic games to distract us.  Active fund managers and advisors who recommend active strategies are the main people I see claiming that passive investing doesn’t exist, but what they say isn’t true.

There is a continuum between passive and active investing; they are not absolute properties.  We can reasonably call an investment approach passive even if it involves some decisions, just as we can call a person thin even if their weight isn’t zero.  We may disagree on the exact threshold between passive and active investing, but the concept of passive investing still has meaning.

By “passive investing,” most people mean some form of broadly-diversified index investing with minimal trading.  Although passive investing usually requires substantially less work than active investing, passive investors still have decisions to make.  They need to choose an asset allocation, funds, accumulation strategy, rebalancing strategy, decumulation strategy, etc.  The term “passive” comes from the fact that there is no need for day-to-day or even week-to-week decisions.  It’s possible for passive investment to run on autopilot for a year without adjustment.  In contrast, more active strategies need closer attention.

The rise of passive investing is a threat to active fund management.  Even factor-based investing that leans toward the passive end of the continuum is threatened by more passive forms of investing.  It’s hard to argue against the success of broadly-diversified index investing with minimal trading.  So, rather than trying to argue in favour of more active strategies, it’s easier to meander into a pointless discussion about how passive investing doesn’t really exist.

“Why should I pay your high fees instead of just owning a passive index fund?”  Active fund managers have a very hard time with this question.  A few meet it head on, but most can’t.  Advisors could launch into a discussion of the value of their services beyond portfolio construction, but some find it easier to launch into “well, you know, passive investing doesn’t really exist, because …”.

We could flip the argument against the existence of passive investing to prove that active investing doesn’t exist.  You’re idle for at least part of your day, so no investment strategy is purely active, and all we have is degrees of passive investing.  More absurdly, there is no pure form of red, so all we have is degrees of blue.  We need to see this claim that passive investing doesn’t exist for the distraction it is.

There is nothing wrong with explaining that even passive investors have to make important decisions.  However, phrased this way, active fund managers would have to explain why their products and services help investors make these important decisions.  It’s easier to deny the existence of passive investing and conclude “you see, there’s not much difference between the investment approach you want and what I offer.”  In reality, there are important differences that should be discussed.