The Problem with Passive Investing

The debate between passive versus active investing never seems to stop, despite the strong evidence that continues to come out in support of the passive side. Many investors still believe in an active investing strategy and the number of active investors has even surged since the pandemic.

Active investing entails frequently buying and selling individual stocks in an attempt to beat the stock market’s average returns. As the name implies, it’s highly involved. Day traders and most Robinhood users who look at the price movement of their stocks multiple times per day would be categorized as active investors. They are trying to take advantage of short-term opportunities in the market.

Passive investing is the opposite as it’s broadly a buy-and-hold strategy. It seeks to maximize long-term returns by minimizing trading. Passive investors believe it’s difficult to out-think the market so instead of trying to beat it, they take what it has to offer with the goal of building wealth over time.

In order to be a successful active investor, you need to know the exact right time to buy or sell and you have to be right more often than you’re wrong. And as it turns out, it’s hard to be consistently right for long periods of time. Generally, less than a fourth of actively managed funds beat the market year-to-year and around 95% of day traders end up losing money.

Passive investing almost always wins in the long run. The historical evidence is now so great that it’s hardly debatable.

So, why doesn’t everyone do it?

Because there is one big problem with passive investing.

It’s boring.

Hitting it big in the stock market by actively trading stocks is exciting. The thrill of trying to double your money as fast as you can is exciting. Consistently investing in a diversified portfolio built to achieve long-term gains is not. Who wants a ho-hum 8% average annual return when you can buy options on Robinhood and try for an 800% return?

Regularly investing with the goal of long-term wealth doesn’t satisfy our hunger for immediate gratification and quick wealth. Contributing to an investment account every month for years can feel monotonous and boring. And because it’s boring it’s hard to stay committed, especially during down markets.

Where an active strategy will attempt to minimize any losses, passive investing accepts the fact that there will be drops with a plan to ride them out. It can be hard to stick to your strategy during such times, but successful long term investors are less concerned with monthly and yearly returns and are more interested in growing their portfolio over decades.

Because of the wonder of compounding, you don’t need the highest investment returns each year. All you need are average returns that you can stick with and that can be repeated for a long time.

That’s why houses end up being a decent investment for a lot of people. In spite of the fact that, on average, houses only appreciate slightly more than inflation, it’s often the only asset that people hold and put money into consistently, every month, for decades.

Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas. — Paul Samuelson

Although being boring is passive investing’s biggest flaw, it’s also its best feature. What it lacks in excitement, it more than makes up for in the free time it provides. Instead of spending countless hours staring at your computer or phone obsessing over which stock to buy or sell, you can spend your time doing what you actually want to do. It allows you to grow wealth while focusing on what really matters, which is living your life.

Most people achieve financial freedom by being really good at doing the boring things.

Thanks for reading!