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Passive vs. Active Investing

July 24, 2013 | About:
Many people wonder how they should invest their money. They weigh their knowledge on the subject with their desired outcome, available time to dedicate to their investing pursuits and their actual ability to get a good outcome. So the question becomes should they index or try their hand at the markets. Three quotes from two well-known investors on whether to invest actively or passively may help clarify the answer.

"Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals." (Berkshire Hathaway Chairman’s Letter - 1996)

"Another situation requiring wide diversification occurs when an investor who does not understand the economics of specific businesses nevertheless believes it in his interest to be a long-term owner of American industry. That investor should both own a large number of equities and space out his purchases. By periodically investing in an index fund, for example, the know-nothing investor can actually out-perform most investment professionals. Paradoxically, when "dumb" money acknowledges its limitations, it ceases to be dumb.

"On the other hand, if you are a know-something investor, able to understand business economics and to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you. It is apt simply to hurt your results and increase your risk. I cannot understand why an investor of that sort elects to put money into a business that is his 20th favorite rather than simply adding that money to his top choices - the businesses he understands best and that present the least risk, along with the greatest profit potential. In the words of the prophet Mae West: ‘Too much of a good thing can be wonderful.’" (Berkshire Hathaway Chairman’s Letter – 1993)

"I have little confidence even in the ability of analysts, let alone untrained investors, to select common stocks that will give better-than-average results. Consequently, I feel that the standard portfolio should be to duplicate, more or less, the DJIA [Dow Jones Industrial Average]." (Benjamin Graham in "The Memoirs of the Dean of Wall Street")

So you must ask yourself: Are you a "know-nothing" investor or a "know-something" investor. If you are a "know-nothing" investor, congratulations, these quotes recommend confidently indexing and spending your valuable time doing other worthwhile pursuits. If you consider yourself, or hope to become, a "know-something" investor, these quotes endorse doing your research and doing it well and then confidently going heavy into a few opportunities that will do well for you in years to come. One caveat: Be sure to track your performance and make sure that you are not fooling yourself into thinking that you can outperform the index. Happy Investing!

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