Recently, I've been thinking a lot about index investing and when it is suitable for an investor to use passive index funds over selecting single stocks for their portfolios.
I have been thinking about this topic because it is something I have been considering myself. Should I be investing in single stocks, or would indexes be a better option for my portfolio?
No clear answer
The way I see it, there is no clear answer to this question. For beginner investors who have just a few thousand dollars to invest and have never touched the stock market before, passive index funds might be the right option.
However, for more experienced investors, with different aims and goals, single stocks mixed with index funds might be a better option.
What about volatility?
One argument that always seems to be left out of the passive versus active debate is the topic of volatility. For the past 10 years, the stock market has only gone up. As a result, many investors have gotten used to an environment where investing in equity indexes only has a positive outcome. For the past decade, whenever the market has dipped, buying has been a great strategy.
History will tell us that this  is not necessarily going to work for the next 100 years. At some point in the next 10 or 20 years, the market may fall by 50% and then go nowhere for a decade.
How would passive investors act in this environment? Right now, it is difficult to tell. Inexperienced investors might move out of passive funds into active, chasing potential returns from managers who claim to be able to beat the market.
But what about single stocks versus passive investing for experienced and intermediate investors?
A question of time
The argument here comes down to time. Research is the most important part of any investing process.
If you do not have enough time to do your research effectively, then no matter how much experience you have as an investor, you are going to be at a disadvantage to the rest of the market.
Research helps reduce risk and reinforce conviction. If you don't do your research correctly, you have no idea how much risk you are taking on and can be easily influenced by Mr. Market and his bipolar nature.
For experienced investors, acknowledging the fact that they do not have enough time to do detailed research could be quite tricky.
Nevertheless, it is essential to admit and understand your weaknesses, especially when it involves investing for the long term. If you know your own weaknesses, primarily your lack of understanding of a particular concept or lack of time to conduct detailed research, you can avoid making dangerous mistakes by merely doing nothing.
That's the great thing about investing. You never have to have a position. You can sit back and watch a company without having to buy shares. Deciding not to enter a stock is just as important as deciding to buy.
The bottom line
These are just some thoughts on the active versus passive debate. This discussion is not intended to provide support for either argument, but highlight why passive investing might be a good idea for active investors if they cannot commit themselves to the time and work that is required to research individual stock positions in detail.
I have decided to allocate more of my portfolio to passive tracker funds and concentrate my efforts on the few positions I know best, rather than diluting my attention.
Although this approach might not be suitable for everyone, it is something I am comfortable with, both psychologically and in terms of asset allocation. That's what really matters.
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