Passive Investing is a long term investment strategy that advocates low levels of trading and keeping costs to a minimum in order to keep the most of your gains. They follow large Indexes of the entire market, or comprehensive sectors thereof. Advocates of Passive Investing also incorporate tax planning in order to minimize portfolio drag during asset growth.
10 Principles of Investing from John Bogle (founder of Vanguard)
1. Remember reversion to the mean
This concept is that as time progresses an assets value will revert closer and closer to its supposed mean value. This concept is a development upon the Regression towards the mean found within statistics. For example, if a coin is flipped the outcome should be equally Heads and Tails, however if you flip it twice it could likely be Heads two times. As the number of events increase, say to 100, then to 1000 and onto infinity the regression should balance out to the theoretical 50/50.
What this means to investors is that if you invest in an asset class over time it should return closer to its theoretical as time progresses, and in a short space of time might appear more volatile than expected. Knee jerk reactions can cost the investor considerable wealth, as the emotion of greed forces a purchase when the stock is high, and the emotion of fear forces a sale when the stock is low.
2. Time is your friend, impulse is your enemy
Start saving early, as time progresses and you combine additional contributions to your savings with a portfolio that is building through Compound Interest you will be able to amass serious wealth by retirement age. Keeping a disciplined strategy and continuing to fund your investments will create an incredibly robust nest egg. Impulsiveness along the way when you see ‘opportunities’ for a quick hit on the market, such as it is appearing to trend in a certain direction can cause greater losses as you are buying into a market based upon a desire for a quick profit, which if turns out badly will come with the desire to cut losses and lose funds that could have built into your long term strategy.
3. Buy right and hold tight
Picking the right investments and being prepared to weather the storm of the market. There will be times when it will feel like a roller coaster ride but selling when your stocks are crashing and buying again when the market is calm, and stable (read it has returned to new highs) will keep costing you money. If the investment is solid stick with it, and if anything add to your position when external forces push it into bargain territory.
4. Have realistic expectations.
This is without doubt the biggest error I made in my trading life. I expected to be able to flip reasonable sums of money into mega amounts, and in doing so too on too much risk… as a person who traded through one of the worst decades in history for the market, in 2001-2010 taking on all that risk wasn’t a very good plan. No doubt I would have got lucky with the same strategy if the market was timed better, in a period of boom, but when it busts it really does expose your flaws in investment strategy. I now set my goal for equity appreciation around 9%; which is still a little ambitious, but a lot more realistic..
5. Forget the needle, buy the haystack.
This is another one of my flaws, I love a couple of ‘needle’ stocks that are sitting out there ready for the plucking – which one of these will be the next Google or Apple? The problem is that for every star there are dozens of duds, and picking through them, even with sophisticated investor information is very much a gamble. Bogle advocates rather than buying just one tech stock, buy them all, spread your risk and reward throughout the sector to create a more stable range of growth (and more importantly, a wide diversification to help protect against loss).
6. Minimize the “croupier’s” take.
This is the house cut on your trade, ironically I used a Casino term for highlighting such fees back in one of my first posts What’s the Vig on That?before reading Bogles 10 rules. The key message here is that a trade isn’t zero sum, the house (brokerage) always takes a piece of the action so keeping that piece as small as possible is the secret to increasing profitability in your portfolio. This applies to both trade fees and management fees, and Bogle was a proponent of low cost Index Funds and ETFs the fees he thinks of are the Fund Expenses/Costs which are advertised as a % figure – try to keep that number under 0.25% (or a quarter of what the traditional Mutual Fund guys are trying to charge you on their best products)
7. There’s no escaping risk.
In order to gain capital appreciation you are going to have to embrace risk as a core part of the ability to gain reward. The aim in accepting risk is not to become reckless, but to understand the relationship between risk and reward for a particular product or strategy. EG, if I offer you the chance to play Heads or Tails with me, and charge $1 for the game, but pay you 75cents if you win, then that is a bad bet… and there are a lot of investments out there that offer worse payouts than that!
8. Beware of fighting the last war.
You have to keep aware of trends in the market. Although Passive Investing does have a very stable and solid approach to the investment process and does look backwards at past performance you have to be wary about putting too much into this. What happened in the past isn’t necessarily going to repeat, and buying a particular stock or sector after a major loss may work out, as it may rebound like it did many times in the past, but it could also drop again, in a never seen before phenomenon. Keep your investments controlled and be careful when you think you ‘see a pattern’.
9. Hedgehog beats the fox.
These foxy brokers offering you convoluted plans and promises of wealth (remember CDOs anyone?) wrapped up in fees and fast talk, don’t be fooled into parting with your money to fancy new ideas that aren’t proven to be successful and the only thing that is tangible about them is the fees that are many multiples of what you would pay in an Index Fund.
10. Stay the course.
Investing is a lifelong process, you will shift allocations at different life stages, but in order to create the wealth we desire in retirement (and early retirement!) there will be times when every strategy fails, but by having a structured, long term vision you will be best prepared to ride out the bad times and enjoy the good.
I found the book The Power of Passive Investing by Richard Ferris a great introduction into this area, he gives valuable insight and lots of comparisons between Passive and Active Investing to show the advantages of this approach – you can get it on Amazon here:
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