Why you shouldn’t be passive about passive investments

Remember the scene from Wolf of Wall Street, where Leonardo DiCaprio is on the phone pitching an up and coming company to someone over the phone? He’s got a potential client on the line. The entire office is huddled around him, like his sales pitch is the only thing happening in the whole world. He’s talking up this one company, how the stock is going to explode and make the client a boatload of money. His only regret will be that he didn’t buy more. 

It’s crazy to think that that’s how things were just a few decades ago. And although the general financial industry hasn’t kept up to date with the progress of technology (we can send people to space for fun but I still need to do a paper application for insurance?) there has been nice progress in some aspects. 

One being, although we have telemarketers, we don’t have people calling us on the phone to put in a trade right then and there. We can do things online, electronically, conveniently. Along with technology has emerged some new strategies that have never before been available to everyday investors. 

Mutual funds have dominated investments options for years, but honestly, they aren’t all that great. Mutual funds are usually diverse, trying to actually replicate the stock markets. If the markets go through a down year, likely so will your mutual fund, and vice versa. Mutual funds typically have high fees because they are ‘actively managed’. At the same time they typically don’t outperform the market. So you’re in a position where you’re paying someone more than you should to try to recreate the stock market in your portfolio. 

So what would be ideal would be a fund that replicates the markets almost exactly (maybe some downside protection to limit losses) but at a lower fee because it doesn’t need to be actively managed. Sounds great right? Let me introduce you to Passive investments. 

Passive investing is just that. 

Instead of trying to strike oil and pick the hot stocks that are going to give you good returns, you invest in everything. By investing in everything, you hold all of the winners and the losers. Historically the winners absolutely outweigh and outperform the losers. The S&P 500 (a fund comprised of 500 American based companies) have averaged over 9% return a year over the past 90 years. If you miss out on a handful of the best performing stocks (lately the FAANG stocks – Facebook, Amazon, Apple, Netflix, Google), or the best performing days, your portfolio reflects it, it does make a difference. You could make an argument that there’s more risk in not owning everything than there is in owning everything. 

So, how many of you today are averaging an annual return of around 9%? I’m going to go ahead and guess not many. The problem with things that are actively managed is the fact that they are actively managed. Human error, human judgement, gut feelings, taking a chance – they are all things that could lead to great things, or horrible things. There’s a difference between investing, and gambling. So because of the human error component and the high fees that are typically associated with mutual funds, actively managed portfolios tend to underperform the market. You end up paying high fees so a subpar solution.

(A great book about Passive investing is Millionaire Teacher by Andrew Hallam, found here). 

Passive investment strategies also typically have lower fees, and usually better diversified with less overlap or repetition than buying a few different funds. A conservative, balanced, and aggressive offered by the same company will typically all own the same stuff, just at different allocations. You think you’re diversifying, but you’re really just buying more of the same stuff you already owned, in a really inefficient way.

By investing in a Passive strategy, you’re betting on every horse in the race. You’re going to win. 

Because Passive investments follow the markets and how they trend, you’re going to feel the ups and the downs. Seeing your account with a lower amount than yesterday because of the markets can be an unnerving feeling. So that’s where having a plan in place is so important, no matter how big or small your portfolio is. You also need to understand that when stocks go down, they go back up. Like our S&P 500 example from earlier, it’s averaged over 9% over a 90 year period. Even through events like The Great Depression, World Wars, stock market bubbles, financial crisis of 2008, and many more.

Who is a Passive strategy right for? 

The easy answer is anyone and everyone. 

Are you investing in a high fee mutual fund that’s trying to replicate the markets but is falling short? You should look into a lower fee, Passive investment strategy. 

Are you looking to get started investing? Maybe starting to save for retirement, a down payment for a house, or anything else? Passive strategies usually have no minimum to get started, take next to no time to get set up and begin saving towards your future. 

Are you either approaching retirement or are in retirement? Why pay someone a high fee to manage your money when you could get better results while keeping more of your money. A conservative Passive strategy will allow you to grow your money safely while paying some of the lowest fees available.

No matter how unique your situation is, there’s always an option for you. Whether you’re already investing or not, it’ll take a little bit of time to explore your options and find the best fit for you, but once you do it’s worth it. The way I like to look at it, is how much time does the average person spend looking for sales, coupons, or deals to save a couple of bucks here or there? In their lifetime: hours, days, weeks, months? In comparison, it may only take an hour or two of your time to get completely switched over to a better, more efficient fund. That could save you hundreds of thousands of dollars for the average person.

Do your future self a favour.

This article is intended for informational purposes only, and should not replace professional financial advice tailored to your circumstances. You should consult a financial professional before making any major financial decisions.

About the Author

Derek Condon, CFP®

Derek Condon is a Certified Financial Planner and Mortgage Advisor specializing in financial planning, investments, wealth-preserving insurance, mortgages, and others. I help my clients with a variety of goals. From someone who is just starting their investing journey to a retiree managing their wealth. From a first-time home buyer to someone refinancing to get their very best mortgage. And, of course, everywhere in between.