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Debating passive vs active investing: Episode II – The Couch Potato Strikes Back

Investing debate: Passive versus active investing

In which the Investor and The Accumulator continue their duel for the soul of investing. Catch up with Episode I or else read on – The Investor having just called out the passive crowd for defeatism, and asking why The Accumulator never even TRIED to be the new Warren Buffett.

The Accumulator: Hang on, I thought I was asking the questions around here? Not sure I like this table-turning…

No, I’ve never been tempted to actively invest – whether it be to pick shares or fund managers, or to time the markets.

I don’t assume I’ve lost without even trying. I’ve surveyed the battlefield, read the casualty reports, checked my weapons (half a brain and a toothpick) and thought, “Do you know what? I’ll just pick up whatever’s left when these guys have finished marmelising each other.”

In other words, the balance of risks is against me. The evidence – and the wise words of many who are far more experienced than I – give me no reason to believe I won’t be the sucker in the room. And considering the stakes are my future, I’ll settle for getting there slowly rather than, say, 20% down or 20% later.

This is not a vanity project. Sure, plenty of people rub along just fine while a plausible man in a suit siphons off a chunk of their wealth, but why be a happy fool?

Someone close to me will live on £12,000 per year for the rest of their life. And 20% less than that is a big deal. Plenty of people retire on less. I may well retire on less because I intend to retire early.

I want every penny to work as hard for me as it can and to make as few mistakes as possible. Maybe this comes from having made plenty of mistakes along the way already.

The UK historical average return on equity in real terms has been 5% per annum. Many think it will be less in the future if we are entering a period of secular stagnation. The thought of losing another 20% of that to fees or foolishness (my own) is unbearable.

What’s that they say: We hate loss more than gain?

Another way of looking at it is that I intend to win without trying. I don’t want to spend my life analysing company financials. This is a means to an end for me, not an end in itself.

Again and again I see people proclaiming things like “America is overvalued”, “I don’t want that much Japan in my portfolio”, and so on. I used to wonder how people knew what fair value was and when an entire continent was pricey.

Now I know that basically they don’t. At best it’s guesswork, mostly it’s gut instinct, and for the majority of people it’s really an attempt to impose a pattern on a chaotic system. It’s an attempt to control the world. To make a difference.

That’s a natural human quality but it works against you in the stock market if you start seeing things that aren’t really there.

So I need to know, in all honesty, what’s your decision worth?

If you knew that in 10 years time you were going to end up 10% down – for all your meddling – would you still do it? Would that be money well spent?

Naturally, you must expect me to attack with Capo Ferro

The Investor: Good question! Because I immediately thought, “Yes, I would, because I enjoy it and relish the challenge and so forth”. But one second later I realised that was nonsense, I wouldn’t do it without the potential to win.

In some ways that’s the most blatantly obvious thing in the world – I don’t want to use the “gambling” word (you know the one… “gambling”) but clearly gambling has no utility if there’s literally no chance to win.

I would imagine playing poker with the leader of North Korea is the most terrifying and simultaneously utterly unsatisfying thing in the world, because all you can do is lose and it’s more than your life’s worth to win. So the first thing I’d say is don’t play poker in North Korea!

The second thing is clearly, no, on reflection if I knew I would end up 10% down, of course I wouldn’t do it. But I think that’s quite a false question. If people knew they weren’t ever going to win the lottery, they wouldn’t play the lottery, even though the odds effectively round down to zero…

But the question is good because it does defuse my “I enjoy it” defense and reveals it as “I enjoy the chance that I might do better”.

Though I still maintain all the rest is true, and running a paper portfolio and following companies without any money at stake, say, would be like playing football without… a football. Just futile running around with no purpose.

It’s also a good question because it does reveal to me, when I think about it, that, yes, I do have an underlying assumption that I am probably going to come up on top of this thing. Not that I will. But that I think I probably will.

If you didn’t think that, obviously you wouldn’t play.

Should I think that? Quick – call a Nobel Laureate! 🙂

The Accumulator: I agree! For once. You only play if you think you’ve got a fair chance of winning.

When it comes to the lottery, I’ve got little chance of winning but the potential payoff is astronomical and the cost of entry is low. That’s why it’s so tempting. I can easily write off the small loss as a price worth paying for the chance to become a millionaire right now for no effort whatsoever. Plus a quick thrill to boot.

But when it comes to investing, although the potential payoff gives me goose-bumps, the cost of entry is high, the effort required is immense, the losses are potentially huge and the odds of winning – as a small-fry investor – are low.

So as a passive investor I refuse to play the game. I redefine winning from beating the market to a pulp to achieving my long-term financial goals. I select low cost index trackers and a strategic asset allocation strategy and now things look very different.

My chances of winning are high, the cost of entry is low, and so is the effort required to play. What I give up is the thrill factor. I won’t shoot out all the lights and get extremely rich very fast.

So I know you know all this and you believe that passive investing is the right strategy for most people. Lots of people know all this and might say that passive investing is the right strategy for other people.

But most active investors think they’re different. They’re special. They’ve got a cupboard full of some secret sauce that means they have a good chance of beating the market. They believe they have edge, as hedge fund manager turned passive investing champion Lars Kroijer calls it.

So the question must be: Why do you think you’ve got an edge?

Well, that’s a cliff-hanger that any soap opera would kill for. You can now heard straight to the final episode of Monevator’s very own Christmas bust-up. 

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