I thought I’d share one of the less appreciated benefits of passive investing after reading Million Dollar Journey’s post on working hard for our money instead of doing the things we value more. Like most Canadians, we work extremely hard – between us we have two day jobs, write a blog, attend graduate school, raise two young children, all the while attending to the endless chores of a normal life – and find that time is a very precious commodity indeed. If finances aren’t your hobby, passive investing lets you get on with your life, whether it is gardening, photography, traveling, spending time with the family or whatever.

Regular readers know that I used to be an active investor. Active investing is definitely fun and perhaps even profitable but it does take a lot of work and research. For example, let’s say that you currently don’t have any exposure to health care in your portfolio and want to add some. Should you buy Pfizer (PFE) or Merck (MRK)? Or maybe, you should invest in a biotechnology stock like Amgen (AMGN) or Genentech (DNA) instead. How about the small biotech companies in the discovery stage? Perhaps, you think that with many prominent drugs coming off patent protection, a generic drug company like Teva (TEVA) or our own Biovail (BVF, for the masochist within us) would be a better holding.

Even after doing your research and picking one, you’ll have to keep track of your holdings. How is company doing with sales and earnings compared to its peers? Has the competitive position changed? Do you still trust the management? On and on it goes and that’s just for one stock position in your portfolio. Let’s say an investor needs 10 to 20 stocks for a fully diversified stock portfolio. Multiply the time needed by the number of stock positions and you’re looking at having a second job which may or may not turn out to be profitable.

As a mostly passive investor now, I find that there is very little demand on my time. Once I decided on an asset allocation and picked a handful of funds or ETFs to hold, the portfolio is more or less on auto pilot. The only thing I then do is rebalance occasionally when adding new savings to the portfolio and trying to be a bit more greedy when our major newspapers report on panic in the stock market in the front pages. The benign neglect benefits the portfolio as well as less activity means fewer opportunities to do stupid things.

This article has 28 comments

  1. Thanks for the mention CC. As an active investor myself, i’m slowly starting to see the advantages of passive investing. Do you set a portion of your portfolio as “play money”?

  2. Canadian Capitalist

    Not really. I still pick stocks actively for the Canadian portion. I don’t buy any speculative stocks – no junior mining companies, drug discovery companies etc.

  3. Millionaireby45

    CC,

    Excellent Post. I originally started as a passive investor, switched to an active investor and now I fall in the middle. My only warning to passive investors is that you still should do your due diligence in ETF’s or Mutual Funds. You may not be as diversified as you think. Currently the TSX is heavily weighted towards energy stocks. By buying an ETF or Mutual Fund that mimics the TSX, and then buying another EFT that follows oil and gas stocks, and a few other ETF’s that follow different sectors, you will be too heavily invested in Oil and Gas to have a well diversified portfolio. Recently, this probably would have resulted in above average returns, but if the price of oil drops significantly than so will your portfolio.

    This is simply a word of caution. Just because you own an ETF or Mutual Fund that mimics the index does not mean that you are diversified.

  4. Canadian Capitalist

    Mby45: Passive investing doesn’t mean buying one index but building a well-diversified portfolio across asset classes with cash, bonds, REITs and broadly diversified stock indices. Take a look at the Sleepy Portfolio on this site for an example. The Sleepy portfolio has only a 20% exposure to Canadian Equities.

    I’d be the last person to advocate sector funds. That’s usually chasing performance. I agree totally that indexing doesn’t mean just buying anything that is called an index fund.

  5. My understanding of what you buy when you buy the tsx comp index as the canadian equity part of your portfolio essentially is buying banks and resources because that is what makes up the bulk of Canadian business. But if you buy the DJ or S&P index you are buying a more diversified index, partly because its a different country but also its a larger market. So would it be safe to say that the DJ/S&P should make up a much larger piece of the equity portion of a portfolio pie?

  6. John,

    I think most would agree that the S&P should make up a bigger portion of one’s portfolio than the TSX (and the Sleepy Portfolio that CC uses does). For me (us) personally, I use 40% S&P index and 25% Canadian equity (some in the index, some individual stocks).

  7. Canadian Capitalist

    John: It’s a tough question. Here’s an article that talks about both sides of the debate:

    http://www.leithwheeler.com/pdf/LeithWheelerQ22005Outlook.pdf

    What I can say is to pick one strategy (i.e. more U.S. stocks than Canadian or vice-versa) and stick to it.

    telly: Most would say the 50% allocation to foreign equities in the Sleepy Portfolio is too much! I don’t know your allocation to cash, bonds and other foreign markets in Europe and Asia and your rationale for what appears to be overweighting US markets. My rationale for the 22.5% US market allocation is that it is roughly the market weight of US equities in the world excluding Canada.

    The funny thing is a recent report indicated that US markets make up just 30% of world markets now. Which means, I’ll have to decrease the U.S. exposure to around 15% in the Sleepy Portfolio if I were constructing it today!

    One thing is certain: we simply have to pick a stance and stick to it. Otherwise, we’ll go mad trying out which is the “best” strategy.

  8. Really, the asset mix (allocation of equities, debt and cash) plays a bigger role in portfolio performance than the actual allocation to specific markets. In the long run, equities should perform roughly the same in every developed market. The main benefit from allocating to different markets is to reduce the covariance of the returns and thus reduce your portfolio’s non-systematic risk. A portfolio that is diversified across markets should have smoother returns (and potentially better risk-adjusted returns), but it won’t necessarily outperform a portfolio that is invested solely in one market.

  9. Great way to put it. Yes, passive investing let’s you have a life.

  10. I’m not sure how to insert a link but here’s the address of another foreign asset allocation discussion that suggests smaller Canadian content….but if you followed this advise most would have missed the last big rise in tsx.

    http://www.efficientmarket.ca/article?story=RRSP_Foreign_Asset_Allocation

  11. Looks like i just figured out how to add links…don’t do anything.

  12. CC: This is the most recent info I have for true global allocation:

    Market Billions in USD Percentage
    Canada $1,193 3.31%
    USA $16,367 45.45%
    Developed $16,526 43.45%
    Emerging $2,830 7.78%
    (I got this from efficientmarket.ca as well)
    But I’m sure I’m not nearly as up-to-date as you. A “new” post on this might be a good thing. I think it’s been a while since you’ve discussed it.

    I increased the Canadian content because of home bias and because some of our portfolio is non-registered (where we hold some Canadian dividend stocks for tax efficiency). I tend to have a fair bit in the S&P because the Vanguard S&P500 index is available in my 401k at VERY low MER and since it’s denominated in USD anyway, it seems to make sense.

    Also, I try not to market time but US markets have performed very poorly and the exchange rate isn’t nearly as profitable as it once was for me (working in the US, living in Canada) so it currently makes more sense to keep more of my salary in USD in a tax-deferred account.

  13. As a newish father myself (21 month-old child), I find it harder to invest actively as well. I only buy individual stocks, but whereas I used to pick stocks with research, I now run “The Magic Formula” screen from “The Little Book that Beats the Market” by Joel Greenblatt. So far the results have been poor, but back tested results indicate a 20%+ annual return. We’ll see.

    I would look for stocks that are lesser known back when I was a stock picker, so I would avoid those tough decisions (eg. Merck vs Pfizer) you refer to in your post.

  14. You can get the most up-to-date global market weights here:

    http://www.globalindices.standardandpoors.com/sandp/CompositeWeight?index=wgbmi&type=b&currency=us

    Currently: Canada 4.38%, U.S. 41.13%, Developed 43.86%, Emerging Markets 10.63%

  15. “after doing your research”.

    What I find interesting in this article is not the active vs. passive question – it’s that this person believes he and others are capable/skilled enough to do the research and pick the stocks thmselves. Honestly, I find this to be a form of insanity. It seems like there is an endless supply of people who think they can do something that they cannot! Why can’t they accept this.

    The “research” thought process is a typical and poor one. Even those simple questions (which won’t ell you if the stock is a good investment) cannot be answered by most people.

    Reminds me of my cousin who near the peak of the tech bubble was telling yours truly what a great bargain Cisco is now that it’s back down to app. $50 and that I should buy it too. I gave her a strange look, and quietly told her that anyone buying tech at these prices should have their head examined. And she was not even a pushy or know-it-all type. Sweet girl. But what were her qualifications to evaluate a company? None! Smart girl, made very good money, successful (in marketing) – but she had ZERO qualifications to evaluate a company. It just never occurred to her that she was attempting something she was not qualified for.

    It’s really an interesting phenomenon. Because investing and trading is accessible to everyone, people don’t even stop to consider whether or not they SHOULD do something just ebcause they CAN do it. I wonder if anyone was allowed to perform neurosurgery if the masses would be lined up to give it a try? heheh.

    The reason the author – and just about everyone else – shouldn’t be active investors is not because they don’t have the time (although that’s a valid reason) – it’s because they are hopelessly underqualified! It’s sheer ignorance to hink otherwise. And just because you hit a winner now and then, or have a few good years, does NOT mean it’s skill folks. The Internet is jam-packed with amateur investors who can’t even read and write the English language nevermind have the right skills and temperment to invest successfully.

  16. Canadian Capitalist

    slick: You should check out the archives because I don’t believe average investors have the knowledge or temperament to pick stocks either. Honestly, I didn’t think I would ever get beat up for not being passive enough!

    laketrout: That’s an interesting table. Bespoke recently posted that USA is about 30% of world markets. I need to take a closer look at this.

    http://bespokeinvest.typepad.com/bespoke/2008/06/shrinking-usa.html

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  19. Great post! I definitely don’t have much time for investment research and use a passive strategy. My kids will only be little for a few years!!

  20. CC,
    “Honestly, I didn’t think I would ever get beat up for not being passive enough!”

    lol.

    Temperment is the key. As I frequently say…”wired”. It is a very rare individual who is wired for success in investing.

    Otherwise, think about it, why wouldn’t MBA’s and CA’s do very well at investing. Surely they know how to crunch numbers and/or understand business.

    Funnier: Even insiders of the public companies are bad at investing in their very own company! Gee, you’d think if anyone would have a grasp on how business will be it would be top level executives at said public company. Nope.

    Most of these well-informed people do poorly when ti comes to investing. It’s not the information. It’s the “wiring” of the person.

    The behavioral finance stuff gets to most of us. Fascinating stuff.

    There’s a Mark Sellers’ speech at I believe a university in Boston (Harvard?) that I think your readers would benefit from. Search for the link, it’s available on the net. I have the pdf if you want me to e-mail it to you. Entitled “So You Want To Be The Next Warren Buffett? How’s Your Writing?”

    It is so rare that I come across anyone even discussing this issue. I find that shocking. Everyone is concerned with buying, selling, stocks, symbols, strategies, fundamentals, technicals, etc., etc. I don’t think I’ve ever seen a discussion (except for one I started) on this extremely important topic.

    The question isn’t “Can I….” – it’s “SHOULD I…..”.

    As for myself, after all these years of investing – and despite doing quite well performance-wise – I have come to the most unsettling conclusion that I should not be doing it. See? Good performance is not enough. In fact, I think it was mainly luck not skill that has gotten me through all these years.

    In my case, it’s not arrogance, but my lack of trust in others. As aware and honest as I am, it’s still very difficult accepting that I shouldn’t be managing my own money. Plus, I don’t know WHO to give my savings over to. Pretty funny quandry for a financial advisor, eh? I’m hoping for the markets to get hit hard, and then I will probably divide my money up between a few holding companies like BRK, Leucadia, et al.

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  22. Slickvguy,

    You talk a lot like a Berkshire Hathaway/Warren Buffett/Charlie Munger acolyte (it takes one to know one). I accept the argument that most people don’t have the temperment to out-perform the market. However, I would argue that it’s both entertaining to try and quite possible to beat the market most of the time.

    Sure, it takes more time and effort, as Ben Graham talks about in “The Intelligent Investor”. It also pays to know about the pitfalls of over-confidence you mention, and how to read a balance sheet, what to look for in terms of integrity of management, and the characteristics of a great business.

    Yes, most people should invest passively, but not all. If someone is keen on studying investing, has good temperment, and can control emotion, they should be able to out-perform the averages.

    Buffett says most people should buy index funds, but he has also said that if he were able to buy every business in Omaha, he wouldn’t buy every one, but would pick and choose, and buy only a handful of the top businesses. Now, we’re not all Warren Buffett, but why shouldn’t a diligent person be able to pick five to ten above average businesses and beat the market? Doing this, it should be possible to avoid most of the market’s worst businesses.

  23. Gene,

    Of course it’s POSSIBLE – because people do it! That much is clear. The proof is there. However, most of the people who do perform relatively well (regardless of whether they under/out perform a benchmark) do so because of randomness and luck in spite of them believeing otherwise. You could be a very intelligent investor, and perform fine, but it could still be because of a number of things other than skill. It’s not just overconfidence – it’s that when people do well they think it’s because they “knew” something or were skilled. They’re just fooling themselves. The market, due to it’s nature, is going to spit out x number of winners no matter if they are blind monkeys or WEB. it’s very difficult to prove that it was skill, especially since in most cases it isn’t. Also, there are people who perform well who do so without much/any skill at all.

    “Now, we’re not all Warren Buffett, but why shouldn’t a diligent person be able to pick five to ten above average businesses and beat the market? ”

    Because picking “five or ten above average businesses” isn’t what it’s about. If only it were that simple. Look at it this way….MANY people can pick good businesses. So why aren’t those MANY diligent people outperforming? heheh. Obviously there’s much more to it than selection.

    The proof is there for all to see. There are very few who over the long-term perform well, and of those most of them do it by pure luck. But in spite of those realities, most people think that THEY somehow are special or skilled investors. I see this every day in my business. Clients who are clueless think they are picking a number at the roulette wheel – and that they have some kind of insight into which number will come up! How many peopel can look int eh mirror and admit that they either are not skilled enough and/or do not have the right temperment for investing. Any? THAT is the point.

  24. In a nutshell: Almost everyone thinks the OTHER guy is the bad driver.

  25. My income is now passive. I just quit my day job 2 weeks ago. I started using some Forex trend predicting software and haven’t looked back. I work 1 hour a day and it’s sooo exciting! The rest of my time is spent having fun 🙂
    You can download it and get started today: http://www.autoforexmoney.com/

  26. Canadian Capitalist

    Anthony: You really are in the wrong place. All I can say is good luck to you.

  27. Why not read ‘The Big Investment Lie” by Michael Edesess?
    It gives some insight into being a decent investor and what an advisor can and can’t do for you. No one looks after your money as well as you do yourself.

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