Why am I a passive investor?

Why am I a passive investor?

A conversation I had a month or so ago is still buzzing round in my head. I was asked about my preference (and the preference of many people in the FI community) towards passive investing versus active investing.

And my debate with myself has me thinking:
What if I am wrong?
I don’t know what I don’t know?
Am I missing something which could result in me stuffing it up for Jonny and our daughter?
If I switch to active could I be better off?
It’s a big responsibility! Aarrrgghhh!

So, I’ve spent a lot of time over the last couple of weeks thinking this through so I can get it clear in my head.

And just a quick explanation on passive and active investment for those reading who are new to this:

“If you’re a passive investor, you invest for the long haul. Passive investors limit the amount of buying and selling within their portfolios, making this a very cost-effective way to invest. The strategy requires a buy-and-hold mentality. That means resisting the temptation to react or anticipate the stock market’s every next move.
The prime example of a passive approach is to buy an index fund that follows one of the major indices like the S&P 500 or Dow Jones (or NZ Top 50). Whenever these indices switch up their constituents, the index funds that follow them automatically switch up their holdings by selling the stock that’s leaving and buying the stock that’s becoming part of the index. This is why it’s such a big deal when a company becomes big enough to be included in one of the major indices: It guarantees that the stock will become a core holding in thousands of major funds.
When you own tiny pieces of thousands of stocks, you earn your returns simply by participating in the upward trajectory of corporate profits over time via the overall stock market. Successful passive investors keep their eye on the prize and ignore short-term setbacks – even sharp downturns.
Active investing, as its name implies, takes a hands-on approach and requires that someone act in the role of portfolio manager. The goal of active money management is to beat the stock market’s average returns and take full advantage of short-term price fluctuations. It involves a much deeper analysis and the expertise to know when to pivot into or out of a particular stock, bond or any asset. A portfolio manager usually oversees a team of analysts who look at qualitative and quantitative factors, then gaze into their crystal balls to try to determine where and when that price will change.
Active investing requires confidence that whoever’s investing the portfolio will know exactly the right time to buy or sell. Successful active investment management requires being right more often than wrong.” - www.investopedia.com

Learning to invest is a personal evolution and you can’t read one article and think you have it sorted, you really have to build up your knowledge and your ‘investing muscle’ over a period of time. The reason I started investing in the first place was because I knew just enough to understand that leaving savings in the bank was a dumb idea. We had paid off our house and we didn’t want another one, so I had to put the money somewhere and holy s**t was it hard finding out just where to put it because the investment space is cluttered and confusing. And after two years of blogging it still is!

 My dog Blue AKA Mr Passive

My dog Blue AKA Mr Passive

I had to dip my toe into the water of investing which I first did with the likes of Bonus Bonds, then with a managed fund (active) and now with index funds (passive). So, I’ve quietly moved away from a very safe investment (but with low returns), to one where a fund manager makes decisions for me (where they actively try to beat the market) to one where I put it on auto-pilot, pay little attention and head out to walk my dog instead (passive, just like my dog).

But the question I was asked was WHY and how did I reach this point?

It’s no wonder that here in New Zealand we lean towards property as an investment because the formula is pretty simple: Buy a house, pay it off, live in it.

In the investment space outside of housing there is a massive amount of information to be found and a massive amount of funds on offer for you to invest in: FundSource produce monthly performance tables for over 1000 funds that are available for investment in New Zealand. They even refer to it as the “universe of funds”. Whether I have $5 or $50 million there is a fund out there for me to invest in and all of them are vying for my $$$. Well it’s just no wonder that I found it overwhelming trying to choose!

I received an email with “breaking news” just last week telling me that yet another KiwiSaver Scheme has been launched bringing the number up to 32 providers. If each of these providers has say three funds within it - conservative, balanced and growth (and many have more than this) then we are now spoiled for choice and have 96 KiwiSaver Schemes to choose from. I have enough of a problem ordering off a menu in a restaurant so this amount of choice is overwhelming for me! Sheesh!

And to add to it is the ongoing discussion of the fees we pay for a service, with some being low and some being extremely high. Fees are the price you pay for an actively managed fund where they pay big bucks to fund managers to achieve higher returns by bringing people on board who have financial knowledge and awareness of the markets and they research and analyse the crap out of every number and statistic they come across looking for any tiny gain they can make. When you look at active management they bandy around terms like “rigorous oversight, exceptional people, robust procedures, clearly defined approach, benchmarks” and all of this doesn’t come cheap. Understandably they want to be paid for their time.

And on the topic of fees the financial advisors or salespeople in the fund have internal performance targets they are aiming for which in my mind would just skew their thinking because if staff have to achieve sales targets you can’t tell me that does not cloud their thinking when they are picking the ‘perfect’ portfolio for you and I? If they were choosing between Fund A and Fund B and Fund A gave them more of a kickback, which do you think they would choose? Now don’t get me wrong, I’m happy to pay for a service and I’m not looking for a zero fee offer, but I am looking to avoid an offer which over time is likely to help the fund manager upgrade their yacht and I’ve read far too many articles telling me that a lot of overseas travel, paid for by the investors, is part and parcel of being an advisor.

And is it just me or have you noticed too that everyone wants me to fill out a questionaire on my “risk profile”?

Because I’m particularly tuned into it I’m also noticing a lot of ads on tellie encouraging me to get my financial house in order, I just need to give the number on the screen a call and they will sort me out… For this blog I was up bright and early each morning reading... reading... reading. Looking at spreadsheets, looking at graphs, following a maze of links. It’s all about “structuring portfolios” etc, jigging, re jigging, etc, either paying close attention to the markets myself or paying someone else to do it so that I don’t miss out on a single dollar. And inevitably somewhere on the website of any fund manager, active or passive is the following statement:
“past performance is not an indicator of future performance”.

Therefore, despite all the complicated math and rigorous oversight they are still taking a punt on the future basically. There are graphs up the wazoo comparing apples and pears and oranges and bananas... There are international studies that have no bearing on NZ but we use them anyway, there are local studies, this study, that study...

Wanna scream yet? I sure do.

And all of these active funds with their clever people involved, how do I know that fund manager Jimmy or Jane was not three sheets to the wind last night and is about to have a REALLY BAD day at the office today and click “buy” instead of “sell”? Jumpy humans can ruin a good thing by getting the jitters or getting excited at exactly the wrong time. From what I have read its Skill vs Luck - few active funds can consistently stay on top and deliver above average returns consistently over a long period of time.

So I have decided that investing in equities is just one giant guessing game, with lots of rules that can be argued about, lots of smoke and mirrors, lots of comparing apples with oranges, lots of marketing campaigns using New Zealand celebrities. And whether the person running the fund is paid a little or a lot, like the rest of us, they are just guessing, but probably with a far better grasp on how to read the markets and a spreadsheet.

 My grandmothers crystal ball

My grandmothers crystal ball

True story: I actually have access to a crystal ball, it was my great great grandmothers and using that I probably have about as much chance of predicting the future as they all do.

For every argument in favour of one form of investing there is a counter argument against it where people with more intellect than me argue the semantics (just read the bottom of any www.interest.co.nz article and you will see what I mean. The level of detail of some of the comments is mind boggling).

Basically, all this financial speak in this huge financial market place can be quite intimidating and the financial industry just feels dirty and greedy to me and I just don’t know who I can TRUST!

The financial community has a very real marketing problem because 1,000 messages are competing for my attention and they all feel like they have an ulterior motive.

Which leaves little old me in the middle thinking ACTIVE OR PASSIVE?

Is this YOU as well? Well, don’t give up, my rant is over, read on....

I started to come across information and conversations that cut through all the noise and made sense to me. They were real people, talking sense and producing graphs I could understand:

This shows that In Australia 63% of actively managed funds underperform the S&P 500

And in America 84.23% of actively managed funds underperformed the S&P 500

The above graphs came from SPIVA, a website that can tell you about the performance of active funds versus the performance of their benchmarks.

I began to learn that although active funds claim that they will beat the market, more often than not, they don’t.

And then I started to discover podcasts that had longer intelligent conversations about how index investing actually works and just why it makes good sense for an investor like myself to consider them. These were proper interviews where the topic was thoroughly dissected and explained in an interesting way, not in a 20 second sound bite interrupted by the interviewer or an advertisement. And it cut through all of the jungle of advice and stopped me agonising over every decision I needed to make.

Honestly, it was like the clouds had finally parted and the sun came out at long last!

I listened to this Choose FI podcast episode where they interviewed JL Collins author of The Simple Path to Wealth and he explain how index funds work:
019 - JL Collins - Stock Series - Part 1

Then this one:
034 - The Stock Series Part 2 - JL Collins

Then I read his book:
The Simple Path to Wealth : Your Road Map to Financial Independence and a Rich, Free Life

Which lead me to learn about Warren Buffet and his 10 Year Million Dollar Bet where he
“argued that active investment management by professionals -- in aggregate -- would over a period of years underperform the returns achieved by rank amateurs who simply sat still. I explained that the massive fees levied by a variety of "helpers" would leave their clients -- again in aggregate -- worse off than if the amateurs simply invested in an unmanaged low-cost index fund.” - 2006 Berkshire Hathaway annual letter to shareholders

You can find out about this bet on a number of websites but here is a good place to start:
Warren Buffett Just Won a 10-Year Million-Dollar Bet: Here's Why

Then I learned about John C. Bogle, or Jack Bogle, founder and retired chief executive of The Vanguard Group and I was officially onboard.

And closer to home I read The Barefoot Investor by Australian Scott Pape.

I had found my tribe. I had found a simple way forward.

Then I found SmartShares in New Zealand and in January 2016 I started buying into the New Zealand Top 50 (FNZ) and then in June 2017 I started with their US 500 (USF) fund. Since then, every month without fail I buy. Month in month out with no plans to sell a single one but plans to invest for many many years to come through good markets and bad.

And here is how it’s working out for me so far:

I’m 44 and I bet I’m part of a large market of people who have money to invest but don’t want to become economists and have to learn the intricacies of ‘the markets’ in order to do it. We might not want to buy a rental property or we might not have enough to buy our first house or we might just have zero interest in property altogether - but we still want to make good investment choices. I might not have chosen the “best” fund and I may well be missing out on great returns? But I have chosen the appropriate fund for ME.

In my case I’ve chosen SmartShares and I am no longer interested in researching that decision because I’m a busy person. I understand that when I buy the FNZ fund through them that I now own a tiny slice of 50 of the top companies in New Zealand. By buying the US 500 I’m buying a sliver of the top 500 companies in America. Through buying the NZ Property fund I’m buying a fraction of real estate in New Zealand. I have not picked the right company or the wrong one. I’ve picked all of them and that seems a sensible way forward. And I understand that the fees we pay for a passive fund in New Zealand are higher than they are overseas but hey, we are a teeny country at the bottom of the world so something has to give right?

My graphs above are heading in the right direction (upwards) so life is all ROSES at this point in time but because of everything I have discovered I know that is very likely to not remain the case and one day I’m going to watch the value of my portfolio plummet - at which point I hope to have the fortitude to turn off my computer and just not look and NOT sell, but keep buying when the shares are on sale and wait the weeks/months/years for the recovery. So, I understand volatility as well and I’m not frightened by it. Apparently we are headed for bumpy markets and this nice run where markets tend to go up will end BUT I don’t think an actively managed fund will be in a better place to predict this than a passive one.

I’m happy having this conservative approach and I gave up trying to understand the enormous industry that is out there vying for my business. I may be missing out? I may be doing better than most?

So if you have an actively managed fund and your fund trumps mine, well big ups to you, great to be YOU and I’m VERY happy for you. But it’s just not for me.

I’m sticking to my passive approach because it was explained to me in a far simpler way than any other form of investing. I don’t have it wrong after all, my investing is simple and I understand it.

Happy Saving!

Ruth

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