So there are two basic strategies to invest, and your first decision as an investor is to decide which road to take. In part 2 we talked about the active option, in part 3 we’ll cover the alternative option: passive investing.
Whereas active investing feels right, passive investing is a little counter-intuitive. You actually don’t have to do anything to be a successful passive investor. You should probably have an understanding of how the market works and have a conviction about why you’re investing the way you are, but as far as activity goes you’re taking it real easy.
One of my favorite analogies for passive investing is salmon fishing. Salmon fishing is not sport fishing, it’s almost like harvesting, like work. The importance is not in casting and reeling (a staple of sport fishing), the importance is in how well you’re set up. You need to have varying types of bait at varying depth of water, you might try variations in boat speed, variations in direction, variations in water depth, etc. The important thing is to be equipped to catch a fish at any moment by diversifying your offering as much as possible. Once you’re all rigged up, you sit back and let the market do its work.
The basic question here is about whether or not you’re confident in the fact that the market is efficient. If you believe the market is efficient (which data supports) any attempt to outperform the market by actively picking stocks or timing the market is vain. Instead of spending time on all different types of analysis and market trends, the focus can be on how to design the most efficient portfolio possible, how to diversify in the best possible way. Instead of trying to bet and predict the market, you simply need to own the market as efficiently as possible. It’s an entirely different game.
Passive investing is a wonderful thing, it reduces a great deal of stress. A poor year of returns is simply a result of the market, it’s not the result of some poor guesses by you or anyone else. A recession is no longer terrifying because you’re well-diversified and you understand that the market always bounces back, that the average market downturn lasts less than a year. Your retirement is no longer a question of ‘if,’ but of ‘when.’ A passive investor is free from analyzing endless piles of company data, the uneasiness about the market sectors they’re invested in. Passive investors don’t have to worry about how the riots in Hong Kong, or Bolivia, or Lebanon, or Iraq will affect their portfolio. It’s an entirely different way of being.
So the first decision you’ve got to make as an investor is whether you’ll be active or passive. That’s certainly not the last question you’ll have to answer, but it’s a very important one and one that set the direction of your investing journey and your financial future.