Passive vs Active Investing

Active vs passive investing

Given a market and any period of time there is a certain amount of growth. For example, in 2019 the S&P 500 went up in value by about 30%. That number is fixed based on the underlying profits of the companies, innovation, expectations of future growth, etc.‎

You can easily guarantee your fair share of that market growth by investing “passively”. That means, buying and holding an index fund. Just simply riding the market and collecting your profits.‎

The alternative is to invest “actively”. Active investment is the act of trying to BEAT the market. For example, in 2019, that would be choosing specific companies within the S&P 500 to try to get more than 30% growth. But here’s the thing: If you do that, the sum total of the growth of the market doesn’t change. That means if you add up ALL THE PROFITS of ALL THE ACTIVE TRADERS, relative to the market, they sum to exactly zero. When someone beats the market, someone by definition loses to the market. But it gets worse. Because active trading is work. It comes with fees. So when you’re PAYING a fee (whether it’s transaction fees, expense ratios, account fees, management fees, advisor fees, etc) you’re now fighting for LESS than your full share of the growth after fees.‎

So if you invest actively in an attempt to beat the market, who do you think you’re reaping those profits from? The other investors who are also paying experts to fight for their remaining share? On the whole, both investors lose, and only those expert helpers profit. Sure, in any given year you might beat the market. But study after study show that’s much more likely to be random, than you finding an especially good expert.‎

So I would suggest this: Don’t worry about trying to BEAT the market. If you want to make more money, focus on putting more money IN (to index funds) to make your share bigger! :)‎

As always, reminding you to build wealth by following the two PFC rules: 1.) Live below your means and 2.) Invest early and often.‎

– Jeremy

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