"Active" Index investing vs. "Passive" Index investing

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GoldenGoose
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"Active" Index investing vs. "Passive" Index investing

Post by GoldenGoose »

First thing first, I fully understand the power of compounding and the benefits of passive investing (set it and forget it). However I would like to question that style of investing for certain individual situation due to the average return of index fund investing. I would like to do a thought process to see if it makes sense.

Let's say there is an individual due to his/her personal circumstances couldn't invest at all until they are 45 years old. So you are looking at a person who has only about 20 years to invest before they have to go conservative. Let's also say that they don't have a lot of money to pump into the market right away, much like a kid who just graduates from college and has their first job. Let's also say that the money each month they contribute to their investment is average, like a 401K, about $1500 a month. So given this setup, is the compounding power of index fund in 20 years be enough for this person? If right off the bat this person was able to put in substantial amount, then I could see the compounding effect. However, this is not the case.

So instead of just putting it in the index fund and let it ride and take a chance that it would return you X% as history has shown, how about taking a look at the individual stocks in that index and then pick a smaller group of best ones based on the individual's DD. Since the index fund already selects quality stocks, you just need to focus on the top quality group in the sectors that you like and know. Buy those stocks and then let them ride. In a sense, it is an index within an index. Monitor those companies and adjust quickly and accordingly if they exhibit any kind of failures (like GE for example). If you must replace a stock, you get another one from that index. This is the active aspect of the investment style.

I know if you stick with the index, you spread the risk but then you would also "compromise" the return (average). With this one, you have a chance of beating the index safely (you get the same stocks as the index's holdings). So for this hypothetical person, I think this is the best way to go.

Remember, this is just purely a discussion of ideas so there is no right or wrong. What are your thoughts?
Last edited by GoldenGoose on Mon Oct 12, 2020 9:54 am, edited 1 time in total.
livesoft
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Re: "Active" investing vs. "Passive" investing

Post by livesoft »

I'm not sure what you think happens in 20 years. They don't go conservative in 20 years. They stay at moderate.
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Johm221122
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Re: "Active" investing vs. "Passive" investing

Post by Johm221122 »

"The best stocks"

Sounds easy but extremely hard.
tibbitts
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Re: "Active" investing vs. "Passive" investing

Post by tibbitts »

Well you could buy lottery tickets too, and hope for the best.

What is DD? I assume not anyone's daughter.

I actually held GE stock once upon a time as an employee, so your "Monitor those companies and adjust quickly and accordingly if they exhibit any kind of failures (like GE for example)" brought back some memories. And then there's "you just need to focus on the top quality group in the sectors that you like and know." You do realize how many highly educated experts are employed full-time for the exact purpose of doing what you're suggesting, and that a significant number still don't manage to do it successfully?

The fact is that many of us, either through our own fault or just circumstances, haven't invested the way we wish we had. But most of us have accepted that the consequences of that are that we'll have less than if we had done better, not that we should attempt some last-minute desperation move to make up for what we have or haven't done before.
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1789
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Re: "Active" investing vs. "Passive" investing

Post by 1789 »

OP

The problem with hand picking a list of top companies in the index is the following. You have 20 years and on average assume 2 recessions. Now assume your initial list have AAPL and MSFT. Think of them started going down the list to the 8th and 10th by market cap and replaced by something else. Lets assume recession hit those stocks 70% and the market by 50%. What will you do? Will you get rid of them and buy something else? Once you start changing the list to new top performers you maybe already late to buy them (aka they may not outpace overall market after you buy).

Remember amazon decreased 93%. From what i know except Jeff and some executives no one has been able to hold on to that stock for 20 years. 20 years for megacorps/big tech is a forever long time. Things may change so quickly.
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alex_686
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Re: "Active" investing vs. "Passive" investing

Post by alex_686 »

There are 2 flawed assumptions.

Risk can be broken down into 1. willingness 2. necessity and 3. ability. They have a low ability to take risk. Suggesting a aggressive risky strategy is probably wrong.

That a aggressive active strategy is better than a aggressive passive strategy. This assumes the person has a high level of skill and luck. Which is probably not true. One could buy a passive portfolio of high risk / high beta stocks. One could use leverage, such as buying S&P futures.
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000
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Re: "Active" investing vs. "Passive" investing

Post by 000 »

GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm taking a look at the individual stocks in that index and then pick a smaller group of best ones based on the individual's DD. Since the index fund already selects quality stocks, you just need to focus on the top quality group in the sectors that you like and know. Buy those stocks and then let them ride.
What if quality underperforms junk?

What if the sectors you like and know underperform the sectors that you dislike and/or don't understand?
GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm Monitor those companies and adjust quickly and accordingly if they exhibit any kind of failures (like GE for example).
What do you mean by this? How will you detect the failures? What is your "failure indicator"?
GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm If you must replace a stock, you get another one from that index.
Most stocks are in some index, like the total market index. I'm not quite sure what you're getting at by limiting your picks to an index. Do you mean limiting your picks to S&P 500 companies?
GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm I know if you stick with the index, you spread the risk but then you would also "compromise" the return (average). With this one, you have a chance of beating the index safely (you get the same stocks as the index's holdings).
No. The part I bolded is especially wrong. Picking a handful of stocks from an index has a high probability of missing a few of the great performing stocks.
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patrick013
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Re: "Active" investing vs. "Passive" investing

Post by patrick013 »

GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm
So instead of just putting it in the index fund and let it ride and take a chance that it would return you X% as history has shown, how about taking a look at the individual stocks in that index and then pick a smaller group of best ones based on the individual's DD. Since the index fund already selects quality stocks, you just need to focus on the top quality group in the sectors that you like and know. Buy those stocks and then let them ride. In a sense, it is an index within an index. Monitor those companies and adjust quickly and accordingly if they exhibit any kind of failures (like GE for example). If you must replace a stock, you get another one from that index. This is the active aspect of the investment style.
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sycamore
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Re: "Active" investing vs. "Passive" investing

Post by sycamore »

tibbitts wrote: Fri Oct 09, 2020 4:33 pm ...
What is DD? I assume not anyone's daughter.
I’m guessing DD means “due diligence”
ivgrivchuck
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Re: "Active" investing vs. "Passive" investing

Post by ivgrivchuck »

GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm
What are your thoughts?
If you hold $1000 dollars and it's not enough to satisfy your basic needs, you can always gamble. With margin, options and derivatives, you can with some thought set up a system where you either end up with $1990 or $0.

The system that you are proposing is much inferior. You make multiple trades and in each trade you pay a spread plus you are effectively playing high stakes poker with top investment pros. The odds of success are much less than going all-in with one bet.

Still, I hope that nobody in his mind is considering something like that. Take a side-kick or anything else instead.
Remember, this is just purely a discussion of ideas so there is no right or wrong.
There are correct ideas and incorrect ideas.
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UpperNwGuy
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Re: "Active" investing vs. "Passive" investing

Post by UpperNwGuy »

GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm Remember, this is just purely a discussion of ideas so there is no right or wrong. What are your thoughts?
Yes, there is right or wrong. See the above comments.,
Doctor Rhythm
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Re: "Active" investing vs. "Passive" investing

Post by Doctor Rhythm »

Just to clarify, an index fund doesn’t select quality stocks. It selects stocks to represent the benchmark, whether those companies are quality or garbage. The problem is that it’s only in retrospect that you can sort out which is which. No offense intended, but your due diligence is about as useful as consulting tea leaves, entrails, or a stock-picking cat.

If picking stocks that will outperform the market were easy, then actively managed funds would consistently beat the benchmark. After all, they are managed by people with far more training, experience, resources, and time than you. Yet the vast majority fail to beat their benchmark over years.
000
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Re: "Active" investing vs. "Passive" investing

Post by 000 »

Doctor Rhythm wrote: Fri Oct 09, 2020 5:57 pm If picking stocks that will outperform the market were easy, then actively managed funds would consistently beat the benchmark. After all, they are managed by people with far more training, experience, resources, and time than you. Yet the vast majority fail to beat their benchmark over years.
Although I agree that the OP's strategy does not seem to be a good one, the comparison with active mutual funds is irrelevant. Active fund managers are hampered by the requirement to remain diversified, publishing their positions, trades that move the market, and investors or oversight committees that refuse to accept underperformance for long. None of those apply to an individual stock picker.
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Re: "Active" investing vs. "Passive" investing

Post by Tattarrattat »

What OP is describing is plain old stock selection. Millions of millions of investors try to do it and fail, including highly paid professionals. If you think you're different and can succeed where others can't, go ahead. The gains of the SP 500 are often due to the gains of just a handful of stocks, can be as few as 10 winners to 490 losers. Picking those 10 is not as easy as one might think or hope it to be.
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Re: "Active" investing vs. "Passive" investing

Post by dru808 »

If you think your active investing is going to return more than an index, I’d say “it’s a no brainer”. Are you certain your active picks are going to beat the market or at least closely track it?
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GoldenGoose
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

tibbitts wrote: Fri Oct 09, 2020 4:33 pm Well you could buy lottery tickets too, and hope for the best.

What is DD? I assume not anyone's daughter.

I actually held GE stock once upon a time as an employee, so your "Monitor those companies and adjust quickly and accordingly if they exhibit any kind of failures (like GE for example)" brought back some memories. And then there's "you just need to focus on the top quality group in the sectors that you like and know." You do realize how many highly educated experts are employed full-time for the exact purpose of doing what you're suggesting, and that a significant number still don't manage to do it successfully?

The fact is that many of us, either through our own fault or just circumstances, haven't invested the way we wish we had. But most of us have accepted that the consequences of that are that we'll have less than if we had done better, not that we should attempt some last-minute desperation move to make up for what we have or haven't done before.
DD = due diligence.

If you dont want to be active in investing then this style is not for you. If you dont like taking risk then this is not for you.
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GoldenGoose
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

1789 wrote: Fri Oct 09, 2020 4:38 pm OP

The problem with hand picking a list of top companies in the index is the following. You have 20 years and on average assume 2 recessions. Now assume your initial list have AAPL and MSFT. Think of them started going down the list to the 8th and 10th by market cap and replaced by something else. Lets assume recession hit those stocks 70% and the market by 50%. What will you do? Will you get rid of them and buy something else? Once you start changing the list to new top performers you maybe already late to buy them (aka they may not outpace overall market after you buy).

Remember amazon decreased 93%. From what i know except Jeff and some executives no one has been able to hold on to that stock for 20 years. 20 years for megacorps/big tech is a forever long time. Things may change so quickly.
Selling stocks solely on price movement is wrong. You end up losing your shirt that way. It has to be fundamental reasons for you to consider selling a stock.
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GoldenGoose
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

alex_686 wrote: Fri Oct 09, 2020 4:40 pm There are 2 flawed assumptions.

Risk can be broken down into 1. willingness 2. necessity and 3. ability. They have a low ability to take risk. Suggesting a aggressive risky strategy is probably wrong.

That a aggressive active strategy is better than a aggressive passive strategy. This assumes the person has a high level of skill and luck. Which is probably not true. One could buy a passive portfolio of high risk / high beta stocks. One could use leverage, such as buying S&P futures.
Not sure I understand.
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Re: "Active" investing vs. "Passive" investing

Post by willthrill81 »

Johm221122 wrote: Fri Oct 09, 2020 4:23 pm "The best stocks"

Sounds easy but extremely hard.
Especially when the lion's share of stocks have not historically done better than T-bills. Virtually all of stocks' historic returns have come from a very small proportion of stocks. If you pick the ten stocks that you think are the 'best', there's a good chance that you will not have chosen any that will outperform the market over time.

Further, the top market cap weighted stocks are far from guaranteed to do well going forward. Every one of the ten largest market cap weighted stocks in the year 2000 went on to underperform the S&P 500 over the next 18 years, usually by a big margin.
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Re: "Active" investing vs. "Passive" investing

Post by alex_686 »

GoldenGoose wrote: Fri Oct 09, 2020 8:59 pm Not sure I understand.
What do you not understand? I am happy to expand.

Are we talking about risk? The fact that such a person has a low ability to take risk?

Are we talking about that being "aggressive" and "active" are on two separate dimensions. That one can be passive and aggressive at the same time. i.e., one can still index and load up on risk. Let us say 60% triple leveraged S&P plus 40% triple leverage long bonds.
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1789
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Re: "Active" investing vs. "Passive" investing

Post by 1789 »

GoldenGoose wrote: Fri Oct 09, 2020 8:58 pm
1789 wrote: Fri Oct 09, 2020 4:38 pm OP

The problem with hand picking a list of top companies in the index is the following. You have 20 years and on average assume 2 recessions. Now assume your initial list have AAPL and MSFT. Think of them started going down the list to the 8th and 10th by market cap and replaced by something else. Lets assume recession hit those stocks 70% and the market by 50%. What will you do? Will you get rid of them and buy something else? Once you start changing the list to new top performers you maybe already late to buy them (aka they may not outpace overall market after you buy).

Remember amazon decreased 93%. From what i know except Jeff and some executives no one has been able to hold on to that stock for 20 years. 20 years for megacorps/big tech is a forever long time. Things may change so quickly.
Selling stocks solely on price movement is wrong. You end up losing your shirt that way. It has to be fundamental reasons for you to consider selling a stock.
Like what? On the paper everyone says the same thing. Have you ever lost 90+% on a stock and hold on to that 20 years? Do you know of anyone who has done it?
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billfromct
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Re: "Active" investing vs. "Passive" investing

Post by billfromct »

Sounds like "momentum investing" to me.

Buy the stocks that have provided the best returns.

It works until it doesn't.

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Re: "Active" investing vs. "Passive" investing

Post by Kelrex »

Oh! Just monitor companies to make sure they're not in trouble? I wonder why so many professional investors go bust when it's that easy??? It's not like that industry is filled with some of the most terrifyingly brilliant and ruthless people in existence...

Sarcasm aside, that's like saying the secret to winning an Olympic race is to run faster.

You know what the biggest potential problem I see with your "pick the best" stock approach is though?? It's that even if you magically could identify the best and strongest companies, you might end up making much less money.

Why? Because your biggest gains will typically be from owning stocks in the smaller, crappier companies *before* they get to be big, stable, "strong" companies.

The major benefit of the index is that a total loss can only lose 100% of its value, but stocks that explode can easily gain many hundreds of percent in value. So when you own a bit of all of them, you capture all of the meteoric gains, which really aren't uncommon, they're just very very hard to detect in advance, so already owning them as part of an index really helps nail that otherwise impossible timing.

It also helps to be invested in the kind of companies that blow up during the kind of economic conditions where other established companies stagnate.

If you select only the "best" companies, those huge gains are baked into the price, you will almost always be off on your timing of buying them. You miss out on the biggest gains, and leave yourself still very vulnerable to the losses because even big juggernaut companies can and do fail. So your net gains over time would probably be less, because you would have almost no huge wins.

So not only is the concept of monitoring companies for possible failure impractical/impossible, but even if you could, you might actually be shooting yourself in the foot and throttling your gains.

Passive indexing is indeed easy, but that's because it's us hitching a free ride. You have to see the value of the insane work underneath it to appreciate just how exceptional you would have to be to beat it.

It's not that you have to be just a bit smarter than the indexers to beat the index, that's not how it works, the indexers are just hitching a free ride on the market, like pilot fish on a shark. You have to be smarter than everyone involved in the entire market to beat *the market itself*, you have to beat the shark, and you're just a fish.
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Re: "Active" investing vs. "Passive" investing

Post by jason2459 »

1789 wrote: Fri Oct 09, 2020 9:19 pm
GoldenGoose wrote: Fri Oct 09, 2020 8:58 pm
1789 wrote: Fri Oct 09, 2020 4:38 pm OP

The problem with hand picking a list of top companies in the index is the following. You have 20 years and on average assume 2 recessions. Now assume your initial list have AAPL and MSFT. Think of them started going down the list to the 8th and 10th by market cap and replaced by something else. Lets assume recession hit those stocks 70% and the market by 50%. What will you do? Will you get rid of them and buy something else? Once you start changing the list to new top performers you maybe already late to buy them (aka they may not outpace overall market after you buy).

Remember amazon decreased 93%. From what i know except Jeff and some executives no one has been able to hold on to that stock for 20 years. 20 years for megacorps/big tech is a forever long time. Things may change so quickly.
Selling stocks solely on price movement is wrong. You end up losing your shirt that way. It has to be fundamental reasons for you to consider selling a stock.
Like what? On the paper everyone says the same thing. Have you ever lost 90+% on a stock and hold on to that 20 years? Do you know of anyone who has done it?
I still own some just about worthless shares of stock I bought just over 20 years in the dot com bubble. I hold it for nostalgic sake. Bought it, did great, went bust. Amazingly that company is still around and I could sell it on the OTC market as they aren't listed on any major boards anymore. It's well over a 90% loss.

Edit: just logged in and checked... total gain,-99.71%. :mrgreen:
Last edited by jason2459 on Fri Oct 09, 2020 9:32 pm, edited 1 time in total.
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1789
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Re: "Active" investing vs. "Passive" investing

Post by 1789 »

jason2459 wrote: Fri Oct 09, 2020 9:27 pm
1789 wrote: Fri Oct 09, 2020 9:19 pm
GoldenGoose wrote: Fri Oct 09, 2020 8:58 pm
1789 wrote: Fri Oct 09, 2020 4:38 pm OP

The problem with hand picking a list of top companies in the index is the following. You have 20 years and on average assume 2 recessions. Now assume your initial list have AAPL and MSFT. Think of them started going down the list to the 8th and 10th by market cap and replaced by something else. Lets assume recession hit those stocks 70% and the market by 50%. What will you do? Will you get rid of them and buy something else? Once you start changing the list to new top performers you maybe already late to buy them (aka they may not outpace overall market after you buy).

Remember amazon decreased 93%. From what i know except Jeff and some executives no one has been able to hold on to that stock for 20 years. 20 years for megacorps/big tech is a forever long time. Things may change so quickly.
Selling stocks solely on price movement is wrong. You end up losing your shirt that way. It has to be fundamental reasons for you to consider selling a stock.
Like what? On the paper everyone says the same thing. Have you ever lost 90+% on a stock and hold on to that 20 years? Do you know of anyone who has done it?
I still own some just about worthless shares of stock I bought just over 20 years in the dot com bubble. I hold it for nostalgic sake. Bought it, did great, went bust. Amazingly that company is still around and I could sell it on the OTC market as they aren't listed on any major boards anymore. It's well over a 90% loss.
If fundamentals have not changed, i would keep it.
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jason2459
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Re: "Active" investing vs. "Passive" investing

Post by jason2459 »

1789 wrote: Fri Oct 09, 2020 9:32 pm
jason2459 wrote: Fri Oct 09, 2020 9:27 pm
1789 wrote: Fri Oct 09, 2020 9:19 pm
GoldenGoose wrote: Fri Oct 09, 2020 8:58 pm
1789 wrote: Fri Oct 09, 2020 4:38 pm OP

The problem with hand picking a list of top companies in the index is the following. You have 20 years and on average assume 2 recessions. Now assume your initial list have AAPL and MSFT. Think of them started going down the list to the 8th and 10th by market cap and replaced by something else. Lets assume recession hit those stocks 70% and the market by 50%. What will you do? Will you get rid of them and buy something else? Once you start changing the list to new top performers you maybe already late to buy them (aka they may not outpace overall market after you buy).

Remember amazon decreased 93%. From what i know except Jeff and some executives no one has been able to hold on to that stock for 20 years. 20 years for megacorps/big tech is a forever long time. Things may change so quickly.
Selling stocks solely on price movement is wrong. You end up losing your shirt that way. It has to be fundamental reasons for you to consider selling a stock.
Like what? On the paper everyone says the same thing. Have you ever lost 90+% on a stock and hold on to that 20 years? Do you know of anyone who has done it?
I still own some just about worthless shares of stock I bought just over 20 years in the dot com bubble. I hold it for nostalgic sake. Bought it, did great, went bust. Amazingly that company is still around and I could sell it on the OTC market as they aren't listed on any major boards anymore. It's well over a 90% loss.
If fundamentals have not changed, i would keep it.
It's an up and coming DOT COM news media company.... 22 years later they are still a new up and coming online only news media company...

So yeah, nothing's changed. lol


Salon Media Group, Inc. Common Stock (PN)
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GerryL
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Re: "Active" investing vs. "Passive" investing

Post by GerryL »

OP,
I'm a person who was pretty much like you described. Didn't settle down into a "serious" job until I was into my 40s, although I had managed to sock a few thousand away in retirement vehicles in the previous half decade. I didn't know anything about active versus passive investing at the time, but went with the lowest cost mutual fund I could find for my IRA. Then when I got a 401k, I just picked an AA I could live with. It wasn't until some years later that I learned about Bogleheads and my employer 401k started offering index funds and I went as passive as possible.

What you describe in your hypothetical sounds like way too much work. I went low cost and passive and saved diligently and increased my savings as that became feasible. In a little over 25 years I had enough to retire comfortably -- without spending a large portion of my remaining life trying to figure out how to beat the index and risking making the wrong moves.
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GoldenGoose
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

000 wrote: Fri Oct 09, 2020 4:55 pm
GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm taking a look at the individual stocks in that index and then pick a smaller group of best ones based on the individual's DD. Since the index fund already selects quality stocks, you just need to focus on the top quality group in the sectors that you like and know. Buy those stocks and then let them ride.
What if quality underperforms junk?

What if the sectors you like and know underperform the sectors that you dislike and/or don't understand?
GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm Monitor those companies and adjust quickly and accordingly if they exhibit any kind of failures (like GE for example).
What do you mean by this? How will you detect the failures? What is your "failure indicator"?
GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm If you must replace a stock, you get another one from that index.
Most stocks are in some index, like the total market index. I'm not quite sure what you're getting at by limiting your picks to an index. Do you mean limiting your picks to S&P 500 companies?
GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm I know if you stick with the index, you spread the risk but then you would also "compromise" the return (average). With this one, you have a chance of beating the index safely (you get the same stocks as the index's holdings).
No. The part I bolded is especially wrong. Picking a handful of stocks from an index has a high probability of missing a few of the great performing stocks.
In an index there will always be sone best performing stocks, some average and then some underperforming. But they have to be quality stocks to be included. Your DD based on your knowledge and experience will allow you to pick the stocks you arw comfortable with. Of course you have to have some kind of knowledge to do this. If you don't, then you shouldn't.

With this active investment approach you have to know how to analyze and recognize the fundamentals of your selected stocks. You have to understand their strengths and weaknesses, their competitors and the sector they belong to. Again if you are lazy and dont want to do anything, then this is not for you.

As for what if what you pick underperforms, underperform as compare to what? The index itself or other stocks? What happens if it outperforms? It would involve some luck here.
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GoldenGoose
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

:sharebeer
ivgrivchuck wrote: Fri Oct 09, 2020 5:48 pm
GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm
What are your thoughts?
If you hold $1000 dollars and it's not enough to satisfy your basic needs, you can always gamble. With margin, options and derivatives, you can with some thought set up a system where you either end up with $1990 or $0.

The system that you are proposing is much inferior. You make multiple trades and in each trade you pay a spread plus you are effectively playing high stakes poker with top investment pros. The odds of success are much less than going all-in with one bet.

Still, I hope that nobody in his mind is considering something like that. Take a side-kick or anything else instead.
Remember, this is just purely a discussion of ideas so there is no right or wrong.
There are correct ideas and incorrect ideas.
I am not advocating active trading. This is like index investing but you are a bit more involved as in monitoring your selections. Its not the buy-and-forget index investing. It is still based on the index but a step more active.
Last edited by GoldenGoose on Sat Oct 10, 2020 5:50 am, edited 1 time in total.
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

Doctor Rhythm wrote: Fri Oct 09, 2020 5:57 pm Just to clarify, an index fund doesn’t select quality stocks. It selects stocks to represent the benchmark, whether those companies are quality or garbage. The problem is that it’s only in retrospect that you can sort out which is which. No offense intended, but your due diligence is about as useful as consulting tea leaves, entrails, or a stock-picking cat.

If picking stocks that will outperform the market were easy, then actively managed funds would consistently beat the benchmark. After all, they are managed by people with far more training, experience, resources, and time than you. Yet the vast majority fail to beat their benchmark over years.
If that is the case then you use your knowledge to pick the better stocks. If you ask me how then I guess we better stop here.
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Re: "Active" investing vs. "Passive" investing

Post by 000 »

GoldenGoose wrote: Fri Oct 09, 2020 10:49 pm In an index there will always be sone best performing stocks, some average and then some underperforming. But they have to be quality stocks to be included. Your DD based on your knowledge and experience will allow you to pick the stocks you arw comfortable with. Of course you have to have some kind of knowledge to do this. If you don't, then you shouldn't.

With this active investment approach you have to know how to analyze and recognize the fundamentals of your selected stocks. You have to understand their strengths and weaknesses, their competitors and the sector they belong to. Again if you are lazy and dont want to do anything, then this is not for you.

As for what if what you pick underperforms, underperform as compare to what? The index itself or other stocks? What happens if it outperforms? It would involve some luck here.
No, they don't have to be quality stocks to be included in a CRSP total market index. They just have to have enough trading float. S&P indices do have a mild quality filter. It offers about as much safety as a filter on a cigarette.

I think I was clear with what I meant about underperforming. Your plan is to tilt towards quality stocks that you know. It is very possible that non-quality stocks do better than quality stocks (likely during unexpectedly prosperous times) or that sectors you don't know do better than sectors you do know. This has been happening to (most) value investors for the last decade. They didn't understand tech stocks, so they didn't invest in them. That didn't work out so well.

It's important to remember the performance of the stock is not equal to the performance of the business, but rather the performance of the business relative to expectations.
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

Tattarrattat wrote: Fri Oct 09, 2020 8:00 pm What OP is describing is plain old stock selection. Millions of millions of investors try to do it and fail, including highly paid professionals. If you think you're different and can succeed where others can't, go ahead. The gains of the SP 500 are often due to the gains of just a handful of stocks, can be as few as 10 winners to 490 losers. Picking those 10 is not as easy as one might think or hope it to be.
The difference here is that you pick stocks from an index. Yes I know. Its a chance you take. If I want average return then I just do the index. If I want a chance to do better than the index, I focus on a core group. Is it a guarantee? No, you migjt underperform but it's a risk if you accept.
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Re: "Active" investing vs. "Passive" investing

Post by Doctor Rhythm »

GoldenGoose wrote: Fri Oct 09, 2020 11:12 pm
Tattarrattat wrote: Fri Oct 09, 2020 8:00 pm What OP is describing is plain old stock selection. Millions of millions of investors try to do it and fail, including highly paid professionals. If you think you're different and can succeed where others can't, go ahead. The gains of the SP 500 are often due to the gains of just a handful of stocks, can be as few as 10 winners to 490 losers. Picking those 10 is not as easy as one might think or hope it to be.
The difference here is that you pick stocks from an index. Yes I know. Its a chance you take. If I want average return then I just do the index. If I want a chance to do better than the index, I focus on a core group. Is it a guarantee? No, you migjt underperform but it's a risk if you accept.
I have no desire to pick individual stocks (and thereby take on idiosyncratic risk on top of market risk) without an expectation of better returns. I’m probably risk tolerant to a fault, but prefer to take my risk via a more aggressive allocation rather than by reducing diversification.

Also, can you explain why picking stocks from an index is preferable to stock-picking without this restriction? Is the benefit of this strategy hypothetical or empirical? It would seem that if the index tracked the total US market or something similarly broad, you could pick any company you’ve heard or any one of thousands that you haven’t and still be “selecting from the index.”
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

dru808 wrote: Fri Oct 09, 2020 8:04 pm If you think your active investing is going to return more than an index, I’d say “it’s a no brainer”. Are you certain your active picks are going to beat the market or at least closely track it?
There is a chance that it will. There is also a chance that it won't. And there is also a chance that it returns the same as the index. So if you have the know-howb the time the interest, the inclination and the desire then this is for you. If not then yeah do the index and get whatever everyone else is getting. Nothing in investing is guaranteed. Even the index investing doesn't guarantee to return you x % gain.
Last edited by GoldenGoose on Sat Oct 10, 2020 5:42 am, edited 2 times in total.
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

willthrill81 wrote: Fri Oct 09, 2020 9:00 pm
Johm221122 wrote: Fri Oct 09, 2020 4:23 pm "The best stocks"

Sounds easy but extremely hard.
Especially when the lion's share of stocks have not historically done better than T-bills. Virtually all of stocks' historic returns have come from a very small proportion of stocks. If you pick the ten stocks that you think are the 'best', there's a good chance that you will not have chosen any that will outperform the market over time.

Further, the top market cap weighted stocks are far from guaranteed to do well going forward. Every one of the ten largest market cap weighted stocks in the year 2000 went on to underperform the S&P 500 over the next 18 years, usually by a big margin.
You hit the nail right on the head with "a small number of stocks contributes to the largest gain". It's true. So because an index includes so many non-performers with a few outperformers, the gain is so diluted. This is the average. With active investing, it is YOUR job to recognize these few outperformed in the index and select them. If I need to explain "how do you know which ones?", then this approach is not for you. Recognizing these few performing stocks in the index takes time, effort, intuition and know-how.
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

alex_686 wrote: Fri Oct 09, 2020 9:10 pm
GoldenGoose wrote: Fri Oct 09, 2020 8:59 pm Not sure I understand.
What do you not understand? I am happy to expand.

Are we talking about risk? The fact that such a person has a low ability to take risk?

Are we talking about that being "aggressive" and "active" are on two separate dimensions. That one can be passive and aggressive at the same time. i.e., one can still index and load up on risk. Let us say 60% triple leveraged S&P plus 40% triple leverage long bonds.
In the given scenario, this person has to have good risk tolerance. If not then just gamble with the index's return in hope that they will have enough money for retirement. However, the risk tolerance here does not equate to recklessness (no lottery, no daytrading, no penny stock speculation).
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

1789 wrote: Fri Oct 09, 2020 9:19 pm
GoldenGoose wrote: Fri Oct 09, 2020 8:58 pm
1789 wrote: Fri Oct 09, 2020 4:38 pm OP

The problem with hand picking a list of top companies in the index is the following. You have 20 years and on average assume 2 recessions. Now assume your initial list have AAPL and MSFT. Think of them started going down the list to the 8th and 10th by market cap and replaced by something else. Lets assume recession hit those stocks 70% and the market by 50%. What will you do? Will you get rid of them and buy something else? Once you start changing the list to new top performers you maybe already late to buy them (aka they may not outpace overall market after you buy).

Remember amazon decreased 93%. From what i know except Jeff and some executives no one has been able to hold on to that stock for 20 years. 20 years for megacorps/big tech is a forever long time. Things may change so quickly.
Selling stocks solely on price movement is wrong. You end up losing your shirt that way. It has to be fundamental reasons for you to consider selling a stock.
Like what? On the paper everyone says the same thing. Have you ever lost 90+% on a stock and hold on to that 20 years? Do you know of anyone who has done it?
Well, yes I still have a stock that I have a paper lost of more than 90% and it is about 15-ish years so far since I bought it. This is a stock I bought many years ago when it was a dominant player in its space. It is not "much" money (5k) relatively speaking. Want to know what it is? BlackBerry. I bought it for its dominance but I failed to monitor it and failed to recognize its failing fundamentals (lack of innovation amid fierce competition). Chalk that up to lack of experience. It is so worthless now that I don't even bother to sell it. There is another one I bought that lost more than half its value for awhile. After 10 years I sold it for a 20% gain. Nothing to brag about but yeah, my investing background does have lessons like those.
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Re: "Active" investing vs. "Passive" investing

Post by sycamore »

GoldenGoose wrote: Sat Oct 10, 2020 5:37 am ...With active investing, it is YOUR job to recognize these few outperformed in the index and select them. If I need to explain "how do you know which ones?", then this approach is not for you. Recognizing these few performing stocks in the index takes time, effort, intuition and know-how.
I suspect it also takes some wishful thinking and/or a crystal ball :)
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Re: "Active" investing vs. "Passive" investing

Post by Uncorrelated »

The correct asset allocation is not influenced by your time horizon. If you believe you can estimate future returns better than the market, then active investing is the right choice. It doesn't matter whether your time horizon is 50 years, 10 years, or 1 month. It also doesn't matter whether you are ahead or behind retirement schedule.

When it comes to active investing, one of the questions you can ask is: what evidence is there that it is possible to beat the market? The evidence on all counts is weak. Momentum investing has no evidence. Volatility managed investing does not appear to be economically significant. Stock picking has no evidence, according to academics not even Warren Buffett's success can be attributed to stock picking. Researchers say there is no evidence that skilled managers exist in the first place. The idea that one can pick winners is delusional and at odds with research literature.

The only people that make money with active management are high frequency traders and a small amount of companies that poured billions in market research, such as renaissance technologies.
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

billfromct wrote: Fri Oct 09, 2020 9:22 pm Sounds like "momentum investing" to me.

Buy the stocks that have provided the best returns.

It works until it doesn't.

bill
No, this is not my suggestion. Momentum investing is to chase after high flyers. This requires active trading. Here you buy stocks from an index that are of high quality based on your research and hold them for the long run.
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

Kelrex wrote: Fri Oct 09, 2020 9:25 pm Oh! Just monitor companies to make sure they're not in trouble? I wonder why so many professional investors go bust when it's that easy??? It's not like that industry is filled with some of the most terrifyingly brilliant and ruthless people in existence...

Sarcasm aside, that's like saying the secret to winning an Olympic race is to run faster.

You know what the biggest potential problem I see with your "pick the best" stock approach is though?? It's that even if you magically could identify the best and strongest companies, you might end up making much less money.

Why? Because your biggest gains will typically be from owning stocks in the smaller, crappier companies *before* they get to be big, stable, "strong" companies.

The major benefit of the index is that a total loss can only lose 100% of its value, but stocks that explode can easily gain many hundreds of percent in value. So when you own a bit of all of them, you capture all of the meteoric gains, which really aren't uncommon, they're just very very hard to detect in advance, so already owning them as part of an index really helps nail that otherwise impossible timing.

It also helps to be invested in the kind of companies that blow up during the kind of economic conditions where other established companies stagnate.

If you select only the "best" companies, those huge gains are baked into the price, you will almost always be off on your timing of buying them. You miss out on the biggest gains, and leave yourself still very vulnerable to the losses because even big juggernaut companies can and do fail. So your net gains over time would probably be less, because you would have almost no huge wins.

So not only is the concept of monitoring companies for possible failure impractical/impossible, but even if you could, you might actually be shooting yourself in the foot and throttling your gains.

Passive indexing is indeed easy, but that's because it's us hitching a free ride. You have to see the value of the insane work underneath it to appreciate just how exceptional you would have to be to beat it.

It's not that you have to be just a bit smarter than the indexers to beat the index, that's not how it works, the indexers are just hitching a free ride on the market, like pilot fish on a shark. You have to be smarter than everyone involved in the entire market to beat *the market itself*, you have to beat the shark, and you're just a fish.
It seems too many people are so conditioned to failure so the only question asked is what if the return is lower than the index. What about what if the return is higher than the index? Isn't that a potentiality? Has anyone done this before to definitively say it doesn't work?
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

jason2459 wrote: Fri Oct 09, 2020 9:36 pm
1789 wrote: Fri Oct 09, 2020 9:32 pm
jason2459 wrote: Fri Oct 09, 2020 9:27 pm
1789 wrote: Fri Oct 09, 2020 9:19 pm
GoldenGoose wrote: Fri Oct 09, 2020 8:58 pm

Selling stocks solely on price movement is wrong. You end up losing your shirt that way. It has to be fundamental reasons for you to consider selling a stock.
Like what? On the paper everyone says the same thing. Have you ever lost 90+% on a stock and hold on to that 20 years? Do you know of anyone who has done it?
I still own some just about worthless shares of stock I bought just over 20 years in the dot com bubble. I hold it for nostalgic sake. Bought it, did great, went bust. Amazingly that company is still around and I could sell it on the OTC market as they aren't listed on any major boards anymore. It's well over a 90% loss.
If fundamentals have not changed, i would keep it.
It's an up and coming DOT COM news media company.... 22 years later they are still a new up and coming online only news media company...

So yeah, nothing's changed. lol


Salon Media Group, Inc. Common Stock (PN)
$0.018 dollar day change,$0.00percent day change,(9.09%)
Bid 0.012 Ask 0.0204. :moneybag :moneybag :moneybag 8-)
So what made you buy into this company in the first place? Dominance in its space? Strong growth? Innovations? Or was it just a shot in the dark? Some people confuse fundamentals with business line.
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

GerryL wrote: Fri Oct 09, 2020 9:56 pm OP,
I'm a person who was pretty much like you described. Didn't settle down into a "serious" job until I was into my 40s, although I had managed to sock a few thousand away in retirement vehicles in the previous half decade. I didn't know anything about active versus passive investing at the time, but went with the lowest cost mutual fund I could find for my IRA. Then when I got a 401k, I just picked an AA I could live with. It wasn't until some years later that I learned about Bogleheads and my employer 401k started offering index funds and I went as passive as possible.

What you describe in your hypothetical sounds like way too much work. I went low cost and passive and saved diligently and increased my savings as that became feasible. In a little over 25 years I had enough to retire comfortably -- without spending a large portion of my remaining life trying to figure out how to beat the index and risking making the wrong moves.
@gerryl Glad that passive investment work out for you. You mentioned being thrifty and good saver. I don't know your income and expense obligation and your retirement lifestyle expectations. Remember there are millions of people in the US who are not a fraction as wealthy as the typical BH-er on this board. They don't even know what a stock or a mutual fund is and yet they live just fine in retirement. But not everyone is the same.
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Re: "Active" investing vs. "Passive" investing

Post by whereskyle »

GoldenGoose wrote: Fri Oct 09, 2020 4:15 pm First thing first, I fully understand the power of compounding and the benefits of passive investing (set it and forget it). However I would like to question that style of investing for certain individual situation due to the average return of index fund investing. I would like to do a thought process to see if it makes sense.

Let's say there is an individual due to his/her personal circumstances couldn't invest at all until they are 45 years old. So you are looking at a person who has only about 20 years to invest before they have to go conservative. Let's also say that they don't have a lot of money to pump into the market right away, much like a kid who just graduates from college and has their first job. Let's also say that the money each month they contribute to their investment is average, like a 401K, about $1500 a month. So given this setup, is the compounding power of index fund in 20 years be enough for this person? If right off the bat this person was able to put in substantial amount, then I could see the compounding effect. However, this is not the case.

So instead of just putting it in the index fund and let it ride and take a chance that it would return you X% as history has shown, how about taking a look at the individual stocks in that index and then pick a smaller group of best ones based on the individual's DD. Since the index fund already selects quality stocks, you just need to focus on the top quality group in the sectors that you like and know. Buy those stocks and then let them ride. In a sense, it is an index within an index. Monitor those companies and adjust quickly and accordingly if they exhibit any kind of failures (like GE for example). If you must replace a stock, you get another one from that index. This is the active aspect of the investment style.

I know if you stick with the index, you spread the risk but then you would also "compromise" the return (average). With this one, you have a chance of beating the index safely (you get the same stocks as the index's holdings). So for this hypothetical person, I think this is the best way to go.

Remember, this is just purely a discussion of ideas so there is no right or wrong. What are your thoughts?
I think a person in this situation will need to 1. delay full retirement and social security payments until 70, and/or 2. bear more risk in an earlier retirement by keeping a higher allocation to stocks, while also delaying social security as long as possible. IIRC, every year social security is delayed provides an 8% return. Not bad for the "fixed income" portion of the portfolio. I personally do not plan to add bonds in the near future and consider social security my "fixed income" retirement investment.

Reducing diversification and increasing the risk of portfolio failure or underperformance before retirement is NOT the prudent decision in my book.
"I am better off than he is – for he knows nothing and thinks that he knows. I neither know nor think that I know." - Socrates. "Nobody knows nothing." - Jack Bogle
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Re: "Active" investing vs. "Passive" investing

Post by onourway »

GoldenGoose wrote: Sat Oct 10, 2020 6:18 am It seems too many people are so conditioned to failure so the only question asked is what if the return is lower than the index. What about what if the return is higher than the index? Isn't that a potentiality? Has anyone done this before to definitively say it doesn't work?
Despite your assertions to the contrary, your idea is not in any way meaningfully different from the active investing that thousands of fund managers attempt year after year. Clearly, it does work for some of them, at least for some period of time. However the number of them that are able to out-perform their index for 20 years is astonishingly close to zero.
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Re: "Active" investing vs. "Passive" investing

Post by JPH »

Why limit your choices to stocks that comprise the index? If you want to try and pick the "best" ones, then pick from the entire universe of available stocks.
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Re: "Active" investing vs. "Passive" investing

Post by Johm221122 »

GoldenGoose wrote: Sat Oct 10, 2020 6:18 am
Kelrex wrote: Fri Oct 09, 2020 9:25 pm Oh! Just monitor companies to make sure they're not in trouble? I wonder why so many professional investors go bust when it's that easy??? It's not like that industry is filled with some of the most terrifyingly brilliant and ruthless people in existence...

Sarcasm aside, that's like saying the secret to winning an Olympic race is to run faster.

You know what the biggest potential problem I see with your "pick the best" stock approach is though?? It's that even if you magically could identify the best and strongest companies, you might end up making much less money.

Why? Because your biggest gains will typically be from owning stocks in the smaller, crappier companies *before* they get to be big, stable, "strong" companies.

The major benefit of the index is that a total loss can only lose 100% of its value, but stocks that explode can easily gain many hundreds of percent in value. So when you own a bit of all of them, you capture all of the meteoric gains, which really aren't uncommon, they're just very very hard to detect in advance, so already owning them as part of an index really helps nail that otherwise impossible timing.

It also helps to be invested in the kind of companies that blow up during the kind of economic conditions where other established companies stagnate.

If you select only the "best" companies, those huge gains are baked into the price, you will almost always be off on your timing of buying them. You miss out on the biggest gains, and leave yourself still very vulnerable to the losses because even big juggernaut companies can and do fail. So your net gains over time would probably be less, because you would have almost no huge wins.

So not only is the concept of monitoring companies for possible failure impractical/impossible, but even if you could, you might actually be shooting yourself in the foot and throttling your gains.

Passive indexing is indeed easy, but that's because it's us hitching a free ride. You have to see the value of the insane work underneath it to appreciate just how exceptional you would have to be to beat it.

It's not that you have to be just a bit smarter than the indexers to beat the index, that's not how it works, the indexers are just hitching a free ride on the market, like pilot fish on a shark. You have to be smarter than everyone involved in the entire market to beat *the market itself*, you have to beat the shark, and you're just a fish.
It seems too many people are so conditioned to failure so the only question asked is what if the return is lower than the index. What about what if the return is higher than the index? Isn't that a potentiality? Has anyone done this before to definitively say it doesn't work?
Yes it has been done before and some afterwards even call it a scam
Last edited by Johm221122 on Sat Oct 10, 2020 7:06 am, edited 1 time in total.
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

Doctor Rhythm wrote: Fri Oct 09, 2020 11:52 pm
GoldenGoose wrote: Fri Oct 09, 2020 11:12 pm
Tattarrattat wrote: Fri Oct 09, 2020 8:00 pm What OP is describing is plain old stock selection. Millions of millions of investors try to do it and fail, including highly paid professionals. If you think you're different and can succeed where others can't, go ahead. The gains of the SP 500 are often due to the gains of just a handful of stocks, can be as few as 10 winners to 490 losers. Picking those 10 is not as easy as one might think or hope it to be.
The difference here is that you pick stocks from an index. Yes I know. Its a chance you take. If I want average return then I just do the index. If I want a chance to do better than the index, I focus on a core group. Is it a guarantee? No, you migjt underperform but it's a risk if you accept.
I have no desire to pick individual stocks (and thereby take on idiosyncratic risk on top of market risk) without an expectation of better returns. I’m probably risk tolerant to a fault, but prefer to take my risk via a more aggressive allocation rather than by reducing diversification.

Also, can you explain why picking stocks from an index is preferable to stock-picking without this restriction? Is the benefit of this strategy hypothetical or empirical? It would seem that if the index tracked the total US market or something similarly, you could pick any company you’ve heard or any one of thousands that you haven’t and still be “selecting from the index.”
If you ever took a look at the investment chart of risk vs return you would see that the higher the return the more risk involved. If you want a guarantee of a fixed return, why don't you invest in CD? Oh you want a higher return but with a bit more risk? There is bonds. Not satisfied with that return? How about index fund? Still not satisfied? Active investing? Still not content? Daytrading or starting a business. Not everyone failed at daytrading, right? If you know of a guaranteed high return (higher than passive index investing), then let us know. Chances are you probably wouldn't. I am restless and I want a return better than index. Before people jump in and say "you can't do better than index", did Buffett gets rich by investing in index? Did he pick individual companies? Oh he did, didn't he? How did he do that, picking the right companies that enriched him? Did he make mistakes along the way? Surely.

Picking stocks (companies) is work (time and skill) and not everyone is up to the task. That's why if you dont have the inclination, stick to index.

The index does not contain all the companies out there. Rather it contains companies representing the market and having certain qualifications. Tsla has huge market cap but it is not in an index ... Yet. (I have a feeling it will but that's another story). So my thought of picking from the index is to limit your research, control the risk and somewhat reflect the chosen indexs holdings.
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Re: "Active" investing vs. "Passive" investing

Post by onourway »

GoldenGoose wrote: Sat Oct 10, 2020 7:05 am
The index does not contain all the companies out there. Rather it contains companies representing the market and having certain qualifications. Tsla has huge market cap but it is not in an index ... Yet. (I have a feeling it will but that's another story). So my thought of picking from the index is to limit your research, control the risk and somewhat reflect the chosen indexs holdings.
I don’t think you even understand what an “index” is in this context. Tesla is most certainly included in the main index I hold. It’s the 9th largest holding. :oops:
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Re: "Active" investing vs. "Passive" investing

Post by GoldenGoose »

sycamore wrote: Sat Oct 10, 2020 6:09 am
GoldenGoose wrote: Sat Oct 10, 2020 5:37 am ...With active investing, it is YOUR job to recognize these few outperformed in the index and select them. If I need to explain "how do you know which ones?", then this approach is not for you. Recognizing these few performing stocks in the index takes time, effort, intuition and know-how.
I suspect it also takes some wishful thinking and/or a crystal ball :)
Luck is also a part of it. There are many well thought out plans out there created by groups of the brightest minds that have gone astray upon execution.
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