Passive investing is touted by Warren Buffet and criticized by Robert Schiller, though it’s hard to argue with the returns enjoyed by many following the approach. With some research, many analysis can be found detailing the pros and cons of each. Fundamentally I believe the decision to go the route of passive investing is based on these emotionally appealing concepts:
Time value of money
- The average investor is a busy human. They’re working, parenting, living, laughing, loving. That doesn’t leave much time to be managing their investments. They want a set-it and forget-it approach to investing that they don’t need to be monitoring regularly.
- The average investor doesn’t have the knowledge to time transactions. If they’re not an economist or financial analyst by trade, how is the average investor supposed to know what stock to buy, when? How could they know to track the details of their transactions and benefit from balancing and tax loss harvesting? And, maybe more importantly, they don’t have the time to learn.
Risk vs Reward
- The average investor has heard these idioms many times, ‘don’t put all of your eggs in one basket’ and ‘in for a penny, in for a pound’. Ideally they’re looking to balance their risk and reward in simple terms. Often-times passive investing allows for simple risk balancing by % asset allocation contributions (whether to stocks, bonds, etc).
- The average investor sees great historical performance. You’ve seen the charts. They always show the same thing: regular investment over many years, unbroken through times of economic downturn, result in returns that are appealing. The only clearly documented risk is the average investor’s desire to pull back investment in times of economic downturn – a pitfall to avoid.
Disdain for costs
- The average investor is attracted to the appeal of low fees. The concept is easy to convey, the less paid in fees, the more that goes to the principle. Most don’t need convincing that this is a good thing for them.
- The average investor is attracted to no trading costs. When participating in passive investing through brokerage firms many self branded have no fee funds and etf’s that cover both discrete market segments and macro view total markets. Purchasing these many times per year at regular intervals enables the average investor to save hefty trading fees around other investment types.
Simple yet elegant
- Passive investing is easy for the average investor to understand because it’s most like the savings accounts they’re used to. Making regular contributions with each paycheck and benefitting from compound interest over time are core concepts of each. The ease reduces barriers to entry that may exist for more complicated approaches to investing.
- Passive investing is easy to setup and plan for. Once the initial account minimum are achieved, it’s as simple as creating a brokerage account and setting up an automatic ongoing transfer transaction from a bank account. Since the contribution amount stays the same with each transaction, it’s easy to anticipate as part of a monthly planning and expense budget.