Investors’ interest in passive investment strategies has surged since the financial crisis. This is no coincidence. Demand for passive products is rising because there is a wealth of research out there showing that over the long term, passive strategies outperform active investing.
Even active strategies that outperform take time to implement. When considering the extra time and effort required to pick stocks, for most investors, it is just easier to go passive.
Passive investing, however, is unlikely to save the average investor from making mistakes. Buying the S&P 500 and walking away for 10 years might seem easy, but there is a high chance passive investors will cash this trade in at the first sign of trouble, or cash out to buy a more appealing stock if they think it will produce better returns.
This is a crucial point in the active versus passive debate. No matter how passive your portfolio is, you are still human and are subject to psychological biases and emotions, which influence investment decisions.
How to be a successful investor
There is plenty of research proving it is not the stocks investors pick that are to blame for poor returns, it is the investors themselves.
To put it another way, you can be a successful investor if you just do nothing, or in the words of Charlie Munger (Trades, Portfolio) “be non-idiotic and live a long time.”
Munger made this comment at the 2015 Daily Journal Annual Meeting. He was answering a question about the temptation to buy highly valued stocks and highly speculative companies. Here’s the full quote:
“Well everybody with any chance at all knows that some companies are better than others. What makes it difficult is they sell at higher prices in relation to assets and earnings and so forth. That takes the fun out of the game. If all you had to do was figure out which companies were better than others, any idiot could make a lot of money. But they keep raising the prices to the fact where the odds change and I always knew that.
They were teaching my colleagues that the market was so efficient that nobody can beat it. But I knew people that beat the para-mutual system in Omaha. I know more about horses than other people. I knew it was bullshit… when I was very young. So I never went near a business school so I didn’t get polluted by the craziness. Never believed it either!
I had a gift for recognizing twaddle and there’s nothing remarkable about it. I don’t have any wonderful insights that other people don’t have. I'm just slightly more consistent than others and have avoided idiocy. Other people are trying to be smarter. All I’m trying to be is non-idiotic. I find that’s all you have to do to get ahead in life is to be non-idiotic and live a long time. It’s harder to be non-idiotic than most people think.”
This quote really resonates with me. Investing is not that hard if you avoid making any large, stupid decisions and let your wealth slowly compound over time.
Knowing your problems before they hit you
Being “non-idiotic” is, as Munger notes, harder than it seems. It is easy to make a spur-of-the-moment investment decision you later regret, which is why many of the best investors take their time in making decisions and employ "second-level" thinking, to borrow a term coined by Howard Marks (Trades, Portfolio).
Thinking separately from the rest of the crowd is easier if you are just aware of it. Being aware of your flaws is the first step in correcting them. If you know humans have a tendency to be “idiotic,” then that is the first step in making sure you can stand out from the rest of the crowd.
