SA: Why I'm Not A Passive Investor

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boggler
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SA: Why I'm Not A Passive Investor

Post by boggler »

When passive investors buy an asset class, they buy at whatever price the seller asks. And when they sell, they sell at whatever price the buyer offers. The "passive" is not about the choice of assets - again, someone has to choose them - it refers instead to passively accepting whatever price the market happens to set for those assets. In contract, an active investor considers a stock and its price and decides whether to buy, sell or hold.

...

I believe many "active" retail investors today are simply people who have completely lost faith in the market. Passive investing - buying small pieces of thousands of securities we know nothing about at whatever price the seller sets in the hope that down the road we can sell them to someone else for a profit to fund our retirement - does not sound like a good plan. Graham and Buffett and Lynch, among others, offer for an alternative that makes sense to us. Buy quality companies at reasonable prices and watch them grow. Ignore (or exploit) the price fluctuations - focus on the company and its ability to generate earnings. And as a direct corollary, don't focus on achieving a superior total return to some benchmark.
http://seekingalpha.com/article/1951921 ... e-investor

What's the best argument against this?
larryswedroe
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Re: SA: Why I'm Not A Passive Investor

Post by larryswedroe »

The simple answer is that there's no evidence supporting the idea that it's likely an active investor will outperform appropriate risk-adjusted benchmarks, something this author doesn't know, or won't acknowledge
Also many of these don't understand that indexing/passive investing doesn't mean exclusive use of an S&P 500 or TSM portfolio.
If you want to outperform either just load up on SV stocks and historically will add about 4% a year. but that's not alpha, it's beta (or loading on the factors of size and value).
If you want a short summary of why this is wrong read The Quest for Alpha
Best wishes
Larry
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DRiP Guy
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Re: SA: Why I'm Not A Passive Investor

Post by DRiP Guy »

boggler wrote:What's the best argument against this?
Results.
Professor Emeritus
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Re: SA: Why I'm Not A Passive Investor

Post by Professor Emeritus »

boggler wrote:
When passive investors buy an asset class, they buy at whatever price the seller asks. And when they sell, they sell at whatever price the buyer offers. The "passive" is not about the choice of assets - again, someone has to choose them - it refers instead to passively accepting whatever price the market happens to set for those assets. In contract, an active investor considers a stock and its price and decides whether to buy, sell or hold.

...

I believe many "active" retail investors today are simply people who have completely lost faith in the market. Passive investing - buying small pieces of thousands of securities we know nothing about at whatever price the seller sets in the hope that down the road we can sell them to someone else for a profit to fund our retirement - does not sound like a good plan. Graham and Buffett and Lynch, among others, offer for an alternative that makes sense to us. Buy quality companies at reasonable prices and watch them grow. Ignore (or exploit) the price fluctuations - focus on the company and its ability to generate earnings. And as a direct corollary, don't focus on achieving a superior total return to some benchmark.
http://seekingalpha.com/article/1951921 ... e-investor

What's the best argument against this?
that it is stupid? you can sucker or fool a "buyer" , but an efficient market is the collective actions of thousands of buyers. Rejecting the market is like saying I don't have to accept sea level, I know better
Last edited by Professor Emeritus on Fri Jan 17, 2014 2:52 pm, edited 1 time in total.
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DRiP Guy
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Re: SA: Why I'm Not A Passive Investor

Post by DRiP Guy »

Okay, okay, I have more to say, but I did want to accentuate that 'results' is paramount.

The rest of the argument for why you should do it, is that passive investors ARE (with apologies) 'buying quality companies at reasonable prices and watching them grow. Ignoring price fluctuations - focusing on the index of companies and its ability to generate earnings. And as a direct corollary, not focusing on achieving a superior total return to some active benchmark."

Given that it's an averaging strategy, the questions resolve down not to the individual company management level, but the overall market health level. IOW, do you believe that the market basket of US plus International stocks you 'pick' are likely to return about 6 or 7 % real, and do you believe that today's valuation levels are not enormously out of line with precedent to the high side? If you don't believe that, or if you 'need' a higher rate of return, or you know some secret non-public info, then you should probably then go individual stock picking, or stay out of equities altogether, IF you think your own judgment and insight is superior to the collective wisdom of the market.
Professor Emeritus
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Re: SA: Why I'm Not A Passive Investor

Post by Professor Emeritus »

DRiP Guy wrote: If you don't believe that, or if you 'need' a higher rate of return, or you know some secret non-public info, then you should probably then go individual stock picking, or stay out of equities altogether, IF you think your own judgment and insight is superior to the collective wisdom of the market.
and all kinds of quacks exist to fleece you when you claim you have this ability. They will sell you sooooper secret inside information etc.
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VictoriaF
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Re: SA: Why I'm Not A Passive Investor

Post by VictoriaF »

"Passive" investors buy and sell very seldom; they just hold the market. Because of their low volume of transactions and the low turnover of their funds, they save significant amounts of trading costs and taxes. When they do buy or sell (or when their index funds buy or sell), they do it at the best price known at the moment. The price may go up or down from there; some active traders may win or lose on the price movements; whereas passive investors get the market returns at the lowest costs.

Brokers and advisers pumping active investments like to appeal to the masculinity of "active" and unmanliness of "passive." Don't fall for this cognitive manipulation.

Victoria
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jwa
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Re: SA: Why I'm Not A Passive Investor

Post by jwa »

I'm not a stock picker. Stocks that I think are great buys many times turned out to be dogs. Warren Buffett is a great stock picker but I am not and studies have shown most people are not either. Then one needs to ask if they are as savvy as Warren Buffett or am I just one of the faces in the crowd. Even Warren Buffett said that the average investor is best served by being in index funds.

I would not try to dissuade anyone from being the next Warren Buffett or being the next day trader millionaire legend. As for me, I am happy with market returns at the lowest possible cost. I decided many years ago that I could not control or predict future stock movements but I could control and minimize investment costs.
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Epsilon Delta
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Re: SA: Why I'm Not A Passive Investor

Post by Epsilon Delta »

boggler wrote:
When passive investors buy an asset class, they buy at whatever price the seller asks. And when they sell, they sell at whatever price the buyer offers. The "passive" is not about the choice of assets - again, someone has to choose them - it refers instead to passively accepting whatever price the market happens to set for those assets. In contract, an active investor considers a stock and its price and decides whether to buy, sell or hold.
What's the best argument against this?
Notice how when you buy they set up an the seller as an adversary and vice versa when selling. They could just as easily have said:
When passive investors buy an asset class, they buy at the same price as other buyers.
I'm not sure how to argue against that, but they are definitely trying to frame the question in a way that is unfavorable to passive investing.
terrabiped
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Re: SA: Why I'm Not A Passive Investor

Post by terrabiped »

Graham and Buffett and Lynch, among others, offer for an alternative that makes sense to us. Buy quality companies at reasonable prices and watch them grow.
That sound great! Except, there are legions of professional investors with mountains of cash looking to buy quality companies selling at reasonable prices. What are the odds that I, John Q Average with my subscription to Motley Fool or Morningstar Stock Investor will find a portfolio of several dozen "hidden" gems that all these professionals haven't already bid up the price on? Also, let's not forget that buffett buys entire companies in sweetheart deals that only he can make with his billions in cash.
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G-Money
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Re: SA: Why I'm Not A Passive Investor

Post by G-Money »

When passive investors buy an asset class, they buy at whatever price the seller asks.
No, they buy at the lowest price the seller will accept. Just like any other buyer.
And when they sell, they sell at whatever price the buyer offers.
No, they sell at the highest price the buyer will accept. Just like any other seller.
The "passive" is not about the choice of assets - again, someone has to choose them - it refers instead to passively accepting whatever price the market happens to set for those assets. In contract, an active investor considers a stock and its price and decides whether to buy, sell or hold.
And the active investor believes he/she knows more than the the other buyers and sellers, including institutional investors managing billions of dollars. The active investor has convinced himself/herself that he/she knows more about the "right" price of a particular stock than everyone else.
I believe many "active" retail investors today are simply people who have completely lost faith in the market.
So?
Passive investing - buying small pieces of thousands of securities we know nothing about at whatever price the seller sets in the hope that down the road we can sell them to someone else for a profit to fund our retirement - does not sound like a good plan.
It's the worst plan, except for all others that have been tried. If you have no informational advantage, this is an ideal plan. And we haven't even discussed costs, yet.
Graham and Buffett and Lynch, among others, offer for an alternative that makes sense to us. Buy quality companies at reasonable prices and watch them grow.
Why can't the market--incredibly sophisticated and intelligent investors who spend countless hours every day analyzing every marketable security--appropriately value every company, be they a "quality company" or otherwise? Why isn't the market the perfect arbiter of "reasonable prices"?
Ignore (or exploit) the price fluctuations - focus on the company and its ability to generate earnings. And as a direct corollary, don't focus on achieving a superior total return to some benchmark.
Brilliant. Now I have no objective means of measuring whether this approach is successful or not!
Don't assume I know what I'm talking about.
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Taylor Larimore
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The best argument is the truth.

Post by Taylor Larimore »

Graham and Buffett and Lynch, among others, offer for an alternative that makes sense to us. Buy quality companies at reasonable prices and watch them grow.
What's the best argument against this?
Mr. Buffett wrote:
"A low-cost index fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth."
Peter Lynch wrote:
The statistical evidence proving that stock index funds outperform between 80% and 90% of actively managed equity funds is so overwhelming that it takes enormously expensive advertising campaigns to obscure the truth from investors.
Best wishes.
Taylor
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lazyday
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Re: SA: Why I'm Not A Passive Investor

Post by lazyday »

OP strategy adds risks compared to passive total market.

- Manager risk (yourself). Easy to make big mistakes in strategy and implementation.

- Uncompensated Unsystematic risk.
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boggler
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Re: The best argument is the truth.

Post by boggler »

Taylor Larimore wrote:
Graham and Buffett and Lynch, among others, offer for an alternative that makes sense to us. Buy quality companies at reasonable prices and watch them grow.
What's the best argument against this?
Mr. Buffett wrote:
"A low-cost index fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth."
Peter Lynch wrote:
The statistical evidence proving that stock index funds outperform between 80% and 90% of actively managed equity funds is so overwhelming that it takes enormously expensive advertising campaigns to obscure the truth from investors.
Best wishes.
Taylor
This is fantastic.
btraven
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Re: SA: Why I'm Not A Passive Investor

Post by btraven »

Good companies are already priced as good companies. You probably don't have any information that is not already reflected in the price. It is not about buying good companies, it is about the odds of knowing with certainty that a company is going to get mo' better or get better faster than the market thinks it will. The odds are pretty low.
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packer16
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Re: SA: Why I'm Not A Passive Investor

Post by packer16 »

I think you have 2 or 3 things going on here that you need to disentangle. First, his argument makes sense that buying broad parts of the market is not the best strategy to out perform. You have to be different and correct. His model is correct. Second, the implementation of this strategy is where most of the underperformance comes from. When comparing active and passive strategy implementation costs (to the fund investor), passive is cheaper so it has a competitive advantage to begin with. Second, the constraints money managers have on their funds prevent them from outperforming by more than the cost disadvantage they have. Some of these constraints include: the lack of the ability to buy more than 5% of a specific company, diversification rules which prevent concentrating on the cheapest equities and the focus of most fund managers to collect assets versus trying to maximize the returns on the assets they hold. There was a recent study on fund performance in the Financial Analysts Journal (Active Share and Mutual Find Performance) that found funds that have high active share (a measure of how different a portfolio was from an index) outperformed other funds (including index funds) and where on average to overcome the drag of expenses. The fund examples they provided were value funds which I think goes to one of Larry's points. What they also found were that funds that took factor bets or were closet indexers underperformed. These funds had low active share but varying amounts of tracking error from an index. I found the results of the study to be true in practice also.

Getting back to some of the points Larry makes, I think once you start loading up on stocks with certain characteristics then line between active and passive from a strategy perspective becomes pretty grey. I think one area where individuals can do better than even index funds is in getting exposure to small and value characteristics of stocks. Funds are constrained by size and diversification rules from being exposed to these factors. Even small cap value index funds have average market caps of $1.5 to $2.5 billion and micro-cap value funds have average market caps of $750 million. Another way individuals can do this is to have higher weightings of stocks that have more small and value exposure. A practical example of this is the AAII shadow portfolio (which you can see on their site). It is a real-time actual portfolio including all costs of micro cap value portfolio not followed by many analysts. I use this portfolio as a benchmark to test if my further tilting towards small, value and neglect are working. So far so good, 10-yr average compounded returns of 35.2% per year versus 19.3% per year for the AAII shadow portfolio. BTW this further tilting leads to less diversification and therefore more short term volatility.

My approach is to assume the market is efficient unless you show that it is not via misvaluation in a security that is either not followed by many analysts or dismissed out of hand without seeing if things are changing (an example of the latter today are Russian oil companies and 18 to 24 months ago BAC).

Packer
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ASUGrad
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Re: SA: Why I'm Not A Passive Investor

Post by ASUGrad »

Passive investing - buying small pieces of thousands of securities we know nothing about at whatever price the seller sets in the hope that down the road we can sell them to someone else for a profit to fund our retirement - does not sound like a good plan.
The seller didn't set the price, the market did. You aren't the only one buying that day and they aren't the only one selling. A combination of buyers and sellers set that price. Yes passive investing does rely on a pretty efficient market so the passive investors need the active investors to all get together and set those prices. You do all the work, you pay some guy to make educated guesses, and we the passive investors will profit from your hard work.
hafius500
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Re: SA: Why I'm Not A Passive Investor

Post by hafius500 »

When passive investors buy an asset class, they buy at whatever price the seller asks. And when they sell, they sell at whatever price the buyer offers. The "passive" is not about the choice of assets - again, someone has to choose them - it refers instead to passively accepting whatever price the market happens to set for those assets. In contract, an active investor considers a stock and its price and decides whether to buy, sell or hold.
This is factually wrong. -It's nonsense.

A passive investor does not buy at the price the seller asks or sell at the price the seller offers.

As a passive investor does not know a "fair" buying or selling price he only can give an order to buy or sell at, e.g., the closing price.
But the closing price is set by active investors who place orders to buy or sell securities.
A passive investor makes "uninformed" trades while the price-setting active investors make "informed" trades.
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Leesbro63
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Re: SA: Why I'm Not A Passive Investor

Post by Leesbro63 »

Related to all this is the claim that most index investors settle for an "average" return. I always snap when I hear that. No, it's not an "average" return...it's a MARKET return. Which has been a better return than most "average" active investors have achieved.
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Re: SA: Why I'm Not A Passive Investor

Post by nisiprius »

Why would any passive investor be seeking alpha? It seems to me that by definition, it is a website for people who have already decided against passive investing.
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