Passive investing, for the uninitiated, is the idea you mimic an index—either through an index fund, an exchange-traded fund (ETF) that looks like the index, or you buy the stocks in an index in perfect proportion to the index (this latter being possible only if you have a lot of money or there aren’t many stocks in the index). Then you simply hold on as the index does whatever it does, forever, come what may, throughout your investing time horizon. The theory is: By simply buying the market passively and holding on, you can do effectively the same as the market—and do better than most people who overwhelmingly lag the market over time by making active decisions that blow up on them.
And there is nothing wrong with that, in theory. If you do this perfectly you’ll lag the market by a hair’s whisker—by whatever transaction costs or fees you incur, but only by that amount. And that’s quite fine. Doing this beats most investors since most investors lag the market.
But then I commonly hear, “Passive investing is easy.” It isn’t. It’s very, very hard.

Passive Is (NOT) Easy

Tactically, it is easy! Psychologically, it’s tough. Buy an ETF that matches your benchmark—set it and forget it. But in my almost four decades managing money and over a quarter century writing for Forbes, I’ve met few investors who can actually do passive investing. Here’s why and how you know.
At a macro view, a fascinating study done by DALBAR, Inc. shows in the 20 years ending 2009, equity mutual fund investors annualized 3.2 percent returns.1 Over the same time, the S&P 500 annualized 8.2 percent2—hugely better—a full 5 percent annual spread. Let me say that again because it’s epic. Investors in funds lagged the market—the very same market those funds invested in—by 5 percent a year.
That’s a lot of buying funds badly. The main reason is that investors behaviorally can’t “set it and forget it” for very long, so they keep inning and outing of the funds and ETFs at all the wrong times whether they’re buying active or passive funds. (This is parallel to why women are better investors than men—coming up in Bunk 18.) If passive were so easy, people would do it in volume—and you could see it. But they don’t. Even in buying passive funds they typically buy high, don’t hold long enough, then bail out at the wrong times.

If Passive Were Easy, People Would Do It

As I’ve said through these pages, investing tends to be inherently counterintuitive. And there are myriad ways our brains go haywire. Again according to DALBAR, the average holding period for all equity mutual funds is 3.2 years.3 (You read that right—3.2 percent returns and 3.2 years.) To do passive right, you can’t sell your funds and change your strategy every 3.2 years—not unless you’re the most exquisite of market timers. And if you are, you wouldn’t be reading this book! For passive to work, you must, truly, set it and forget it for your entire investing time horizon. And if you’re considering a passive equity strategy, your time horizon isn’t 3.2 years—it’s almost certainly very much longer. (See Bunk 3.)
There are two major forces at work here. One is the desire to in-and-out the market. The other is the desire to shift from this type of index to that. One guy decides at the end of 1995 to be passive to the S&P 500, but at the end of 1999 switches to the tech-heavy and very hot Nasdaq. Why? The S&P 500 annualized 26.4 percent from 1996 to 1999. Nice! But the Nasdaq annualized 40.2 percent.4 Super hot! He thinks he chose wrong, and decides technology is forever the best—and makes his move just before technology tanks hard and then the market. Yuck. He chose wrong again (he thinks). By 2002 he has switched to a half S&P 500, half 5- to 10-year US Treasury ETF strategy, just in time for the bull market to begin. By 2006, he’s tired of lagging stocks and is back to being all S&P 500—just in time for the next bear market to start late 2007. This is all myopic—and he’s even averaging slightly longer than that 3.2-year holding period. But it still isn’t nearly long enough to do anything but be destructive—giving great glee to The Great Humiliator (Bunk 8).
Folks who study behavioral finance know human brains aren’t hardwired to turn a tough shoulder to any form of big volatility, like 1998’s huge correction (Bunk 7) or the massive bear market that ended March 2009. Even normal corrections within normal bull markets create enough volatility to make grown men cry for their mommies. Many professionals (maybe most) can get seriously rattled by big market volatility—even if they rationally know market volatility is normal (Bunk 5). And when stocks are high-flying—like in the late 1990s, or in 2009 when global stocks surged 73 percent from the bottom through year end5—many naturally want to think the big returns they got are due to their genius, not the market overall being up a lot. Overconfidence likely torpedoes as many portfolios as fear of volatility does. But it also speaks to most investors being emotionally unable to set it and forget it. People just can’t.
That’s why, though passive investing is tactically easy, so few investors can actually do it for long enough periods to make it work. It’s sort of like getting a bug and going to the doctor who gives you two weeks’ worth of pills to take. You take two days’ worth and then are annoyed when you don’t get better instantly. So you go do something else, and you’re mystified that you’re still not getting better—and maybe you’re getting even sicker! This is pretty much the same thing. Most people emotionally can’t keep taking the medicine when it tastes bad.

Other People Are Like That! Not Me . . .

You may say, “Other people are irrational like that. Not me! I am cool and steady.” Congratulations! Maybe you are one of the few—ice water in your veins—and can do passive, successfully, for 20 years or more. Folks who stay cool and don’t get knocked asunder, falling to the thrall of a hot asset class (or the chill of a cold one), almost certainly do better than most investors. (But if you think that’s you, mark these pages and flip back the next time stocks fall 15 percent—a normal-sized correction within a bull market—and see if you are so very cool and steady then.)
Fact is: It’s darned hard for almost everyone. It’s so easy to succumb to greed, fear, pain, regret, overconfidence, and your Stone Age brain. So get some form of adviser—your spouse, minister, brother, parent, 65-year-old son, investment adviser, Tinker Bell, whoever—but someone who, every time you try to stray from your long-term strategy, reminds you who you are, and that you’re not Warren Buffett. (Again, if you were, you wouldn’t need to read this book.) And if you need help designing your long-term strategy, get help with that too. (Also, see Bunk 4.) Falling victim to your emotions doesn’t make you a bad person—just human. And if you can control yourself, it can make you a better investor. Yet for most humans, passive investing is hard. Real hard!
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