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'Passive Investing' Is for People Who Don't Know These Investing Principles

Nov 27, 2017

Rahul Shah, Editor, Smart Contrarian

Financial blogs and websites have lately become captivated by a shiny new concept: 'passive investing'.

This mechanical, laid back style has really caught on big time, especially in the developed markets.

According to Forbes, since the year 2000, money has been steadily flowing out of actively managed funds and into passive ones. Actively managed mutual funds in the US have seen roughly US$ 1. 5 trillion of outflows with passively managed ETFs capturing nearly all of it.

And recent predictions are betting that 50% of all assets under management in the US will be 'passively managed' by early 2018. These are huge numbers any way you look at it.

Passive investing really is a tempting idea. It's getting increasingly difficult for any individual investor to consistently beat the benchmark. And although today's fund managers are much more skillful than their ancestors, their skills relative to the rest of the investing crowds are still quite narrow. This makes sustained outperformance extremely difficult.

So, even if a fund manager has enjoyed an impressive run, odds are his performance will revert to average sooner rather than later.

As an investor, you must begin to wonder by now why pay these guys huge fees when all they have to show for their performance is a big red mark against their names.

Your Investing Success Depends on the Path You Choose

What's not helping matters for active managers is some of their own ranks are turning against them.

Warren Buffett, the most visible flag bearer of active investing is going around town extolling the virtues of passive investing.

In his most recent shareholder letter he paid the ultimate compliment to John Bogle, the pioneer of passive investing. Buffett wrote...

  • If a statue is ever erected to honor the person who has done the most for American investors, the hands-down choice should be Jack Bogle.

To be honest, based on facts alone, it is difficult to argue against Buffett and the whole passive investing tribe.

If four out of five fund managers find it hard to beat the benchmark indices, they really don't deserve the high fees they charge. In fact, the fees end up eating into the already below par returns they generate for their investors.

That said, I wouldn't recommend totally giving up active investing either. If you follow some sound investing principles, there's a strong possibility that you will outperform the benchmark indices over a long-term period.

Benjamin Graham, the father of value investing, and my own personal investing hero, highlighted exactly such principles in an insightful speech he gave back in 1963. While his entire speech is brilliant and worth reading, the below passage highlight his key recommendations that show you how you, or anyone, can outperform the markets consistently.

  • I do believe it is possible for a minority of investors to get significantly better results than the average.

    Two conditions are necessary for that.

    One is that they must follow some sound principles of selection which are related to the value of the securities and not to their market price action.

    The other is that their method of operation must be basically different from that of the majority of security buyers. They have to cut themselves off from the general public and put themselves into a special category.

It's that simple. The only way to outperform the market over the long term, Graham says, is:

  1. To always buy a stock at a discount to its intrinsic value; and

  2. Operate differently from the rest of the investing herd.

If the herd is buying up more stocks, you reduce your allocation; and if the herd is selling off stocks, you buy more.

Just follow these two principles, based on the overall valuation levels of the broader market, and you can be among the few who can consistently beat the markets.

My Microcap Millionaires service has used these principles to outperform the market by nearly 3x since inception. And all we've been doing is following the two principles highlighted by Benjamin Graham half a century ago.

Good investing,


Rahul Shah (Research Analyst)
Editor, Smart Contrarian

Editor's Note: What if there was a simple, effective way to fund your retirement without a) scrimping today b) handing over your money to some so-called money manager or c) depending on anyone else. Would you be interested? If you are, click here to find that way.

Brain Food for the Day

Ever Heard of the Loser's Game?

In a professional sports tournament, the guy who executes the more difficult moves is the one who usually wins. Whereas in a tournament for amateurs, the guy who commits fewer errors is more likely to win. Famous finance author Charles Ellis likes to call the former 'a winners' game' and the latter 'a losers' game'.

So where does investing stand? Well, investing is a losers' game, according to Ellis. While it may appear that professional fund managers who are talented and bright may be able to beat the markets, this is not true. On the contrary, it is the market that ends up beating them.

Therefore, the only way to win in investing is to commit fewer errors i.e. things like not making losing investments, not trading too frequently, and keeping it simple as much as possible.

While this is true and makes a lot of sense, it is possible for a small number of investors to beat the markets as we just highlighted. The way to do this is to stick to sound principles and not give in to greed or fear.

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2 Responses to "'Passive Investing' Is for People Who Don't Know These Investing Principles"

Anand Pratap rao

Nov 28, 2017

Thought provoking yet simple to comprehend

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Jashwant Singh

Nov 27, 2017

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