There is a big debate in investing these days around what is better: active or passive investing. The reality is that, while there certainly is a spectrum ranging from highly active day traders to those who buy and sell securities relatively infrequently, there is no such thing as truly passive investing and in fact it could be dangerous to even suggest someone should be passive in their investment program. Cases in point:
What to Buy. Two decades ago there were fewer than 5 index funds; today there are many thousands of index mutual funds, ETFs and other investment vehicles. There are nearly as many investible low cost index ETFs and mutual funds as there are individual stocks. So which one or ones are best for you? Most people point to the S&P 500 index fund (you can buy the SPY or any of the dozens of equivalent funds) but is that the right investment for everyone? What if it were 2007 and you were a couple years away from a financial event (needing money for college, buying a home in the next year or two, beginning to pull money out of an IRA, etc.) and you put all of your money in SPY only to see it drop nearly 50% over the following 12 – 18 months? Then instead of having $100K as a down payment on a house, you had $50K. Clearly SPY is not the right investment for someone with a short-term time horizon. Rather, someone with a time horizon of about 3 years or less should have some bonds, perhaps gold, etc. Within those areas there are literally hundreds of ETFs to choose from. You can hardly be passive when it comes to constructing a well-diversified portfolio consistent with your time horizon (Short term? Long term? Some of each?) and investment objectives (Income? Growth?) given the thousands of options available to you.
When to Sell. Investing is a means to an end, be it paying for school, a house, or expenses during retirement. In many cases, however, you don’t need all the funds at once. A typical retiree withdraws less than 5% of her portfolio in any given year. So the question is: when do you sell your stocks (or bonds or gold or…) to have the cash available to pay for your living expenses in retirement? The day before your mortgage is due? A year before? What if you wait until the last minute and that $4,000 mortgage payment turns into $3,600 due to a BREXIT type single day decline? Clearly decisions need to be made regularly about when to sell a given asset in order to have cash for non-investment purposes.
What to Sell. A well-diversified portfolio typically holds hundreds of securities in a variety of asset classes. If you are raising cash for a life financial event, which do you sell? If an asset class, or individual stock or ETF is doing very poorly, when do you bail? Or do you buy more? If an asset is reaching bubble territory (think tech stocks in the late 1990s, commodities a few years ago), should you heed advice and sell before your holdings drop off a cliff, even if f you don’t need the money anytime soon? Even the great ‘buy and hold forever’ Warren Buffett is constantly buying and selling stocks based on relative valuations.
Tax Loss Harvesting. If you are investing in a non-qualified account and you have realized some gains during the year – or the fund you own pays out capital gains which is common – which stocks do you sell in order to minimize your tax bill? Do you buy the same ones back 31 days hence? What if they have rallied a lot in the interim? Do you put the capital somewhere else?
For a variety of reasons, despite the hype around passive so-called robo type investing, the reality is that there is no such thing as truly passive investing. To be sure, trying to time the market or chasing after the latest fad stock after it has already tripled in price is a great way to lower your returns. But there are myriad legitimate, prudent, rational reasons for being active when it comes to your long-term investment program. The key is to focus on what activities really matter. Spend your time reacting to things entirely outside of your control and which come and go with their proverbial 15 minutes of fame, and you can all but assure yourself of sub-par results. Get the big stuff right, the things you can control (being well diversified, owning high quality companies, not reacting to every headline blaring form the TV or newspaper, etc.), and your chances for long-term success increase dramatically.