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Weekend reading: Passive investing is about logic, not rhetoric

Weekend reading

Good reads from around the Web.

Even as passive investing in index funds stealthily takes over the investing world, the media and many investing professionals still seem in denial, if not downright hostile.

Perhaps I shouldn’t complain.

Every Saturday morning I review the investing links I’ve found in the previous 6-7 days that have any relevance to UK readers. Often – like today – the passive haul is about as bountiful as you’d get if you drift-netted the Dead Sea.

For now at least, the role for Monevator on the Web seems intact. That’s personally reassuring given seven years of Saturday morning link-compilations and all the writing we do in-between, but I’m not sure it’s good for investors.

For example, one UK blogger said the only place he saw the news that Vanguard had cut its charges on UK ETFs was here on Monevator.

He wasn’t right about that, a quick Google Search reveals. It’s true though that the news wasn’t exactly flashed in lights. The Telegraph even managed to find a negative spin, with a headline warning of a catch. Platform charges could be a sting in the tail, the article went on.

Fair enough, but why is that headline news when it’s equally true of all funds?

Up denial river

It has been interesting watching the criticisms of passive investing evolve over the years since the idea was introduced by John Bogle in the 1970s.

First it was ridiculed, and then decried as unworkable.

When index trackers proved totally workable, detractors started championing the superiority of active managers – even as the threat of passive funds and the difficulty of consistently beating a benchmark turned many of them into closet trackers.

Becoming desperate, some have called passive investing “un-American”. Presumably the idea is it’s better to reach for glory and fail – in the spirit of the American Dream – than to settle for average. Rather like a beautiful young person who goes to Hollywood to become a star and ends up a stripper and in later life a bag packer at Walmart. At least they lived their dream, right?

Actually, I have some sympathy for that view when it comes to business, art, sport, and becoming the next Isaac Newton.

However I don’t believe many young people’s burning ambition is to enrich the financial services industry by paying high charges.

Another tack that’s been gaining ground this year has been to simply declare the active versus passive debate ‘boring’.

I admit that hurts, though I suppose we’re biased here on Monevator.

If anyone is an indexing trainspotter it’s my co-blogger, and I know that some of you would be happy to stand beside him at passive investing’s metaphorical Clapham Junction.

When you’re wrong, even when you’re right

Another new tack was taken this week, in a rather strange article from Cullen Roche at Pragmatic Capitalism.

Roche constructs what’s in my opinion a straw man argument that says passive investing must – by his definition – involve buying the global market exactly as you find it, with the same weighting towards equities and bonds.

He then argues that since this is impossible, passive investing (by his definition) is impossible, and adds that those of us who advocate passive investing likely “don’t understand there is no such thing.”

He presents no evidence for the latter point, he just declares it.

Roche also implies that anyone who did passively invest to exactly mirror the global market – again, his definition of passive investing, remember, which he has already implicitly conceded nobody does because he’s already told us it’s impossible – would basically be an idiot, because sometimes assets prove to be overvalued.

He cites a few active managers who took a stand about some asset or another and were right and says that’s why they’re on a pedestal.

“What’s rational about being overweight bonds after the biggest bull market in history?” he asks.

I don’t know, most passive portfolios don’t advocate that so I’ve never looked into it. Only his phantasmagorical version does.

Theory versus reality

I am in no way personally attacking Roche here, just the thrust of this piece. In fact I’ve linked to other articles of his in the past, and if you ignore the screeds about “this ‘passive’ investing ideology”, you might find even this article a thought-provoking read.

It’s that tone I don’t get. I really don’t understand why he’s running around in circles to lambast something that he’s just invented as a problem.

I also disagree with his implication that since some managers could do better than the passive approach, passive investing has a big weakness as a strategy.

That isn’t the point. The reality is vanishingly few managers do better, even if the efficient market hypothesis leaves sufficient room to make outperformance possible.

Given that, why should investors choose active funds if they want the best chance of appropriate returns?

There’s no logic. They are not investing to support careers in the financial services industry, or to play some great game of finding a needle in a haystack. They just want the best odds of a decent return.

You see this time and time again. Fund managers and platform spokespeople saying passive investing is all very well, but some manager beat the benchmark last year or last decade or whenever, so choose them.

It’s a fallacy if what you’re after is the likeliest shot at near-market returns.

Know what you’re doing and why

None of this is to say I am against investing in active funds if you’re prepared to do worse for a chance to do better.

Equally, I am right behind you if you want to stock pick your own portfolio.

I do, and for now I wouldn’t have it any other way. That’s the great irony of this website (and why my co-blogger writes most of the passive articles!)

But my personal preferences are no argument against passive investing. Nor is a complaint about the word ‘passive’, nor is the fact that one in a 100 fund managers (or one in 50 or one in a 1,000 – it really makes no difference to the logic unless it were one in two or so) beats the market for long enough for it not to be a fluke.

Methinks they doth protest too much.

From the blogs

Making good use of the things that we find…

Passive investing

  • Peter Lynch was wrong – Rick Ferri
  • Nothing else. I’d love to feature more UK relevant passive stuff but nobody writes it. Maybe instead you could ‘Like’ Monevator on Facebook to help spread the word? We’re Like-lite! 🙂

Active investing

Other / both articles

Product of the week: Hmm… It seems that if you switch to an M&S Current Account via MoneySupermarket before 31 October you’ll get an M&S gift card worth £125 – but that’s the only way you’ll get it. Have the putative comparison sites done this sort of ‘exclusive deal’ before?

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1

Passive investing

Active investing

  • Robert Shiller: The US is expensive but the UK looks okay – ThisIsMoney
  • Why the US stock market rally could run for years – Business Insider
  • Tesco investors ignored the warnings [Search result]Terry Smith / FT
  • How the Internet really hurt Tesco [Free reg. required]FT Alphaville

Other stuff worth reading

  • UK mortgage lenders are playing extend and pretend – ThisIsMoney
  • Smallest house in the world: Yours for £275,000 – Guardian
  • Got 7,500 years to double your money in cash? [Graphic]Businessweek
  • A real-world retirement success story – MarketWatch
  • The stock market no longer drives the economy… – Fortune
  • …and what venture capitalist Peter Thiel is doing about it – Fortune
  • Don’t buy a beachfront property – Slate

Book of the week: It’s only just out, but I’ve already seen some positive write-ups for Deep Value by Tobias Carlisle, presumably based on review copies. (Given the book’s hefty price tag, it had better be a good read!)

Like these links? Subscribe to get them every week!

  1. Reader Ken notes that: “FT articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”.” []
{ 10 comments… add one }
  • 1 Retirement Investing Today September 6, 2014, 12:12 pm

    Great post TI. Here’s my Reality. I live a boring, mechanical, low expense Index Tracker (ETF and Mutual Fund) based, low tax investment philosophy with a big dollop of regular savings being regularly directed in to it. 7 or so years in and it’s taken me from nothing to sniffing early retirement in under 10 years. Thinking of Fred Schwed’s book it’s more and more looking like I’m going to end up with the ‘yacht’ rather than my banker, broker or fund manager.

    Of course it (and to a lesser extent the funds within it) is never going to make the front page of The Telegraph. Why? Simply we just don’t have the resources of the active fund industry et al marketing machines to help us secure front page thinly veiled advertisements. Why? Because that cash is compounding nicely in our portfolios building our ‘yacht’ wealth.

  • 2 Willem de Leeuw September 6, 2014, 12:49 pm

    As I’ve said before, active investing doesn’t have to be about beating the market, it can be about earning a reasonable rate of return for less than market risk (and ‘ active’ doesn’t have to mean paying a fund manager, you can hold stocks cheaply directly). The thing that annoys me most about the active vs. passive (and equities vs bonds vs cash) debate is that it’s almost always presented as all our nothing, but I guess that makes for better copy. Sure, you can do it like that but why not have a core part of your portfolio which is passive and another part where you speculate? Or don’t. Who cares as long as you make an informed decision. This argument will never end and middle of the road people like me will be annoyed by both sides shi don’t worry, you’ll still get your clicks.

  • 3 Alex September 6, 2014, 3:38 pm

    1. You’re right about the recent trend for some to dismiss the active versus passive debate as “boring”. Hargreaves Lansdown, for example, has been doing that a lot. It’s laughable.
    2. But it is progress, I suppose: before the Bristol firm didn’t even acknowledge the existence of index-trackers. Then apparently the only funds suitable for the public were those run by “star” managers.
    3. Thank goodness Dampier et al. were able to identify funds that would outperform in the future. Because no one else could – or can.

  • 4 dearieme September 6, 2014, 5:04 pm

    “This is Money’s trip to interview Professor Robert Shiller was paid for by Ticino for Finance, which promotes Lugano as an international financial centre.” I’m not sure that I’ve ever seen a declaration of interest like that.

    They would be interesting in the Guardian. “Polly Toynbee admits that her readers pimp off the poor and therefore oppose any policy that might reduce their numbers.” Fat chance.

  • 5 L September 6, 2014, 6:06 pm

    Thanks for the comments on Mr Roche’s piece.

    From my perspective, Mr Roche is conflating two entirely seperate ideas: the Efficient Markets Hypothesis (EMH) and passive investing.

    Passive investing is not based on the principles of the EMH. And this has been made clear by John Bogle (http://www.ft.com/cms/s/0/df6ff27e-08c5-11e3-ad07-00144feabdc0.html?siteedition=uk and http://www.vanguard.com/bogle_site/sp2004AIMRefficientMrkts.html). Whilst passive investing does follow from the EMH it fundamentally draw from the idea that investment costs are a significant drain on the investor. I think this where Mr Roche ‘misses the point’.

    An index, by its very nature is an arbitary collection of securities (as stated many times by Mr Bogle). To give a limited analogy. I could shop at the local corner shop or Aldi. The corner shop is more expensive. When I go shopping I have to allocate my money to various types of food. It is physically impossible for me to buy every single type of food in the shop. So I allocate my money to the food I most desire. What allocations make have no difference to the fact Aldi is cheaper. And that is it.

  • 6 Acky September 6, 2014, 7:31 pm

    This article gets full marks just for the use of the word ‘phantasmagorical’ alone!
    Keep up the good work!

  • 7 Guy September 7, 2014, 8:42 am

    I converted from an active to a passive portfolio about 2 years ago, tweaking the Tim Hale portfolio you guys posted on Monevator. It’s been good, requiring minimal effort on my part, but it’s nowhere near as fun! I miss the active days 🙁

    All the best,


  • 8 interestingreadinglist September 7, 2014, 4:12 pm

    Passive investing is not interesting or sexy, as aren’t a lot of industries that make money.

    All things that are sexy to write about are massively over saturated, but what is most important is to produce that which is useful to others.

    I personally find this website very useful so thanks.

  • 9 Croydon - John Retired September 8, 2014, 4:38 pm

    What many people forget is that we reach this active vs passive conclusion my various routes and experiences. There is no single right answer, you have to believe in the theory of compounding.

    For me it all started after retirement when my IFA led me astray and I felt I could do just as well at lower cost. Time will tell.

    Personally your website led me to Tim Hale and the framework for the decisions I needed to make but did not have the understanding or tools to know how. I am happy that I have dumped Fidelity as a platform and most active funds. I now have a mix of ETF’s, clean class OEICS and Cash.

    Most importantly it took me about 2yrs to work out and transfer our life savings into a Vanguard portfolio and Company I trust on platforms that offers fixed costs, iWeb and Alliance trust. I may miss out on other more lucrative opportunities but at my age (68) there is no necessity to chase them.

    Monevator has been an invaluable asset.

    Many thanks

  • 10 The Accumulator September 8, 2014, 8:37 pm

    Lovely to hear the tales from people who’ve found financial peace-of-mind through passive investing and the part Monevator has played in that. Your journey is my journey.

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