Almost everywhere in life, the word “active” has a positive connotation. An active lifestyle, an active personal life, an active participant in a discussion, etc. In contrast, “passive” stands for low-energy, dull and boring. Imagine setting up a friend on a blind date with a nice gal/guy who has a really great “passive lifestyle” and see how much excitement that generates.
But investing is different. Passive investing is the rage right now! It is a noticeable market trend in finance overall and the Financial Independence blogging world seems particularly subscribed to the passive investing idea. For the most part, I agree with the superiority of passive investing. But then again, not all active investment ideas are created equal. And that means that we are at risk of throwing out the baby with the bathwater!
Has the Personal Finance Passive-Pendulum swung too far? Are we willfully ignoring some useful principles from active investing for fear of shaking the foundations of the Passive Investing Mantra?
Take the following five examples of active investing. They all fall into different spots on the Futility vs. Opportunity spectrum:
- Stock picking.
- Style investing, i.e., tilting the portfolio toward a theme such as dividend yield, small stocks, value stocks, low volatility stocks, etc., or a combination of them.
- Allocation to different asset classes (e.g. stock, bond, cash, alternatives) in response macro fundamentals (P/E ratios, bond yields, volatility, etc.).
- Changing the major asset weights over the life cycle, e.g., using an equity glidepath to retirement and even throughout retirement.
- Setting the initial safe withdrawal rate in retirement and all subsequent withdrawal rates in response to changing market conditions.
It would be a mistake to apply the same passive investment mantra to all five aspects of personal finance. So, that’s what today’s post is about: Where should we stay away from active investments and where can we learn something from active investment principles? Let’s look at the five active investment themes in detail…