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.
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If asked the question "Why should I pay high fees instead of owning a passive fund?" and got a response that "Passive investing doesn't exist" I might be tempted to overlook that and say, "Ok, but funds with low fees do exist?".
ReplyDeleteI view most commission based financial advisors as salesmen rather than investing experts. Generally, I'd say salesmen are pretty smooth at redirecting lines of questioning that might prevent or reduce sales opportunities. I think in most cases, it isn't to be deliberately misleading. They probably often believe what they are saying is true and relevant.
In the case you highlight here, their point is somewhat true (as you demonstrate in your post), but it lacks relevance. The real questions are "Why pay high fees?" or "What value do I get from paying higher fees?".
It's not commission based financial advisors that I hear making the argument that passive investing doesn't exist (although some might do so). It tends to be fund managers and high end financial advisors.
DeleteYou are saying that if an advisor or fund manager tried to distract you from high fees by talking about how passive investing doesn't exist, it wouldn't work on you. That's good. It wouldn't work on me either. However, it could easily work on someone less confident about how to proceed with their investments.
Fund managers and advisors encounter potential investors or clients all the time who've heard of passive investing. Because it's hard to attack the concept of low-cost passive investing, they sometimes attack the term "passive". I would say that this distraction lacks relevance, but I'm guessing it often works. I don't think the effort to stop others from removing the term passive from investment discussion lacks relevance.
Yep. Heard this exact line of argument. By a lucky coincidence he was a financial advisor. Among other claims, he asserted that buying S&P500 or any other index was active investing because S&P/FTSE/MSCI have to decide which companies to include in the index.
ReplyDeleteI think the guy was genuine in his firm belief in the binary world of absolute actives and passives with nothing qualifying as the latter. People tend to hypnotize themselves to believe in things that work for them. In the same breath he claimed that active investing beats passive which was interesting given that “passive does not exist”.
I like the contradiction. Your story reminds me of the Upton Sinclair quote: "It is difficult to get a man to understand something when his salary depends upon his not understanding it."
DeleteYou hit the nail on the head.
DeleteWith a mix of ETFs and dividend growth stocks, my response would be "Fees matter much more than if investing is passive or active. If you can minimize your fees, as an overall market ETF or buying an holding (for a very long time) good dividend growth stocks does, then the active versus passive argument is mute."
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