TMCnet Feature
September 17, 2013

Why Passive Investing Trumps Active

As an up and coming investor (or even if you have a few years under your belt), you’re often faced with a big conundrum: Should you choose passive or active investing? There’s a good chance that you already favor one over the other, because different personality types are naturally drawn to passive or active. However, that doesn’t mean you should rely solely on instincts and comfort; this is your money, and you should make a conscious decision about how to invest it.

Just like it sounds, passive and active tout very different approaches. Just like the rabbit and the hare, slow and steady almost always wins the race. With active investing, you get a thrill and might get a big windfall every now and then—but do you want to play chicken with your money? A more careful, passive approach might be more conservative, but it’s also safer. Also called “evidence-based” investing, passive investing is the approach du jour, especially after the Great Recession.

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Why Boring is Better

Granted, there are nowhere near as many thrills with passive investing when compared to active, but according to research published by MoneyZen, passive is historically more lucrative than active investing—and that’s really all that matters. Sure, there are pros and cons with both styles of investing, but gambling should be left on the casino floors. Are you really up for losing all of your investments?

If you’re naturally an active investor, you probably think that markets in general aren’t very efficient. You tend to look for the extreme examples, the loopholes, and keep an eye out for mispriced securities that can be bought or sold at a profit. The bulk of your investing time is likely spent looking for a rare opportunity, which means a lot of time looking at financial reports, studying economics and trying to predict just about everything. That’s certainly an active approach!

Time Better Spent

While active investors are very much involved, it’s also very stressful. You might feel like you thrive in that environment but it’s also taking a bit toll on you. On the other end of the spectrum, passive investors generally think of markets as efficient. They look at the big picture, the long run, and think that stocks and bonds are a good indicator of the actual value of the securities. You don’t want to succeed over the market, but actually become a part of the market.

This is usually achieved via ETFs and index funds. You probably depend on asset allocation to create a rich and diverse portfolio with a good amount of risk, but with plenty of safety nets. There’s not as much thrill, and active investing remains the most popular at 79 percent of mutual fund investors considered active. However, if active were the most efficient, then wouldn’t the majority of investors be raking in the dough?

Look at the Winners

The old advice of dressing like the job you want is also true with investing—but you need to mimic the actions of successful investors. Most of them are passive, such as Tim Sykes (News - Alert) who become a very young millionaire by sticking to a passive strategy that works. He’s also more than happy to mentor other investors, as long as they’ll follow his lead. And why shouldn’t you?

Investing simply isn’t a gamble, and looking at the data it’s clear that the most successful people are passive—so why doesn’t everyone adopt that approach? Simple: It’s not as fun, it’s not as exciting and the lure of a big win is too much for some investors to ignore. However, investing isn’t a game; it’s an approach to money management. Make the most of it.

Edited by Alisen Downey
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