Passive and active investing are two ways to make investment returns in the stock market. Since my first job in finance, I've always actively invested some of my funds to chase unicorns. The question is: what is the best split between passive and active investing in the stock market?
If you are only a passive investor, you won't be able to outperform the market (S&P 500 or your index of choice). In fact, you're guaranteed to slightly underperform the market due to the small fees. But at least you'll save on larger fees and grow with the market. You'll also outperform people who don't even bother investing in the stock market.
However, if you are an active investor, you have a chance at outperforming the market. Unfortunately, the long-term data shows that roughly 80% of active investors underperform their respective indices over time. Hence, your chances are likely not very good either.
However, as an active investor, you can put some money to work in companies you love whose products you use. You can buy stock in companies that have rejected you. Heck, you can even take a punt at finding the next multi-bagger winner.
It was my active investment in a now defunct Chinese internet stock in 2000 called VCSY, that enable me to come up with a 20% down payment on a San Francisco property in 2003.
There is always a hot stock that could make (or lose) you a quick fortune. They are just hard to find and time right. But that doesn't mean you can’t try with the proper risk parameters.
Hard To Outperform In The Long Run
Unfortunately, the track record for outperformance isn't that great for active investors. We know from the data that investing in passive index funds over active funds is the way to go over the long run.
No rational person would keep on investing in an actively managed fund or hedge fund that regularly underperforms its benchmark. Unless you are truly a gambling addict, no rational person will continue to day trade stocks if he is consistently losing money.
Yet, despite the logic, active equity funds still account for about 50% of the entire assets under management of all funds. Why?
The simple reason is that a minority of active equity funds do outperform their respective benchmarks. Thanks to social media, the appearance of people who outperform is also amplified.
When we see such outperformance, this creates hope. We, humans, live on hope as well as a good dose of investing FOMO.
In this post, I'd like to share my thoughts on various splits between passive and active investing in the stock market. I do believe investors should invest some of their capital in individual stocks and/or actively-run funds. I'll also discuss which type of person is most appropriate for each of the four splits.
Please do not confuse the percentage split between passive and active investing with the asset allocation between stocks and bonds, and other risk assets or your net worth asset allocation.
The split between passive and active investing is part of your overall stock allocation. Although you can clearly be an active and passive investor in bonds and other asset classes as well.
Recommended Split Between Passive And Active Investing
“Nothing so undermines your financial judgement as the sight of your neighbor getting rich.” – J.P. Morgan
There is no absolute correct way to invest. In general, since most people are not professional investors, the majority of your investments should be in passive index funds and ETFs. But what should that majority percentage in passive index funds or ETFs be?
Let me share the recommended split between passive and active investing and which split is most appropriate for which type of person.
100% Passive / 0% Active Investing
100% passive is for those of you who don't care about outperforming the benchmarks. You are also happy with getting rich slowly. You are unwilling to take any chances outperforming the benchmark if it means risking underperforming the benchmark. Maybe you are retired and want the ideal return scenario stable returns and income.
Investing in an actively run mutual fund with high fees is an anathema. You could give two craps about where the portfolio manager and analysts went to school and their investment track record. Further, you're a busy professional and/or parent who has no interest or time in following the stock market. Your expertise in making money lies elsewhere.
You love the K.I.S.S. motto when it comes to investing because you'd rather never think about your money. You have so many more important things you want to do with your time.
We know that the average investor only returned 1.9% a year between 1999 – 2018, according to a report by J.P. Morgan Asset Management.
The average investor trades too much, buys too high, and sells too low. The average investor is an emotional wreck. As a result, the average investor would do best to protect oneself from oneself by investing in mostly passive index funds.
You believe the primary way you will reach financial independence is through steady investment contributions over time.
Further, a decent part of your compensation is in the form of your company's stock. As such, you already have individual stock exposure.
The vast majority of actively run equity mutual funds underperform their respective indices over a 10-year period. Therefore, why bother investing in actively run equity mutual funds or try to pick stocks on your own.
75% Passive / 25% Active Investing
You want to get rich quicker than the average person. My average net worth guide for the above average person motivates you. Therefore, you are willing to take more risks. You believe you can sometimes choose the right funds and the right stocks that will help give your overall investment performance a boost each year.
You are a rational investor who also enjoys following the markets. Perhaps you studied economics or finance in college or graduate school. Maybe you like to regularly read personal finance blogs like this one.
You're willing to recognize market trends and bet accordingly. You may even have a slight edge in a particular sector due to your occupation.
If an emerging trend seems obvious, you're willing to invest in a sector fund or invest in individual stocks that should benefit from said trend. You also like to invest in products you use. Nothing feels better than enjoying the product and making money on the product to then pay for the product.
At the same time, you also realize that consistently outperforming your target benchmarks over the long run is impossible. Therefore, you keep three times more assets in passive index funds. Your active investments are in mostly sector ETFs instead of individual stocks.
For a passive plus strategy, you may want to consider investing through a robo-advisor like Personal Capital. Personal Capital will construct a passive investment portfolio with mainly ETFs for you based on your risk tolerance.
If you don't want Personal Capital to manage your investments automatically, you can still use their free financial tools to manage your own money.
50% Passive / 50% Active Investing
A 50% active percentage is the highest percentage I recommend for all equity investors. For those of you who invest for a living, a 50/50 split may be for you. You go to bed at night thinking about your investments. You wake up at least two hours before the market open to read all the news.
Instead of listening to a riveting whodunnit podcast, you'd rather listen to quarterly company earnings calls. Instead of reading a great novel, you'd rather read company financial documents and S-1 filings. You're hooked on the stock market!
Every day, there are fantastic businesses being built or crazy market manipulation stories to follow. To not look for these potential winners would be foolish. They are all around us. You believe capitalism is the greatest system in the world.
Despite know the odds are against you, we all also suffer from a little Dunning-Kruger (delusion). After all, you've got to be a little crazy to believe you can consistently beat the odds. Yet, there are people who do.
For those of you who have at least 10 years of investing experience, who have at least beaten your target benchmark for at least five years, who have the time, and who simply love the process of investing, a 50/50 split may be appropriate for you.
A 50/50 split might also be appropriate for younger investors (<30 years old) who don't have as much to lose. It's best to learn with less money whether you are a good active investor or a bad active investor.
If you find yourself to have investing acumen, you can gradually build up the absolute dollar amount and percentage. Or, you can allocate your active money to private funds so that connected people can invest for you.
>50% Active, <50% Passive Investing
You're a professional money manager who picks stocks for a living. You're also required to have skin in the game by investing a percentage of your bonus or salary into your fund. This way, you feel the pain of your losses and the glory of your wins. Many hedge funds require its employees to invest this way.
You're also someone who loves everything about the stock market. Investing doesn't give you stress. It brings you joy! How the heck are you ever going to find the next Google, Facebook, Amazon, Tesla, Microsoft, Dominoes Pizza (!) if you don't actively pick stocks?
Based on your long track record, you are considered a great investor. You've been able to outperform the S&P 500 or your index of choice more years than you underperformed by at least a 2:1 margin.
If you are financially independent or have other means of generating income, it's easier to take more active investment risk. For example, you might operate a profitable lifestyle business or have a large trust fund. You also may not have kids.
You've got a lot of pride. You believe that if you can't outperform the market, then what good are you as a finance professional? It's important to constantly prove your investment prowess on a meritocratic battlefield. You don't want to be one of those guys spouting off investing advice with a small portfolio that is perpetually underperforming.
Since most of us are not professional money managers, trust funders, or have profitable lifestyle businesses, I don't recommend having more than 50% of your investments in active funds and individual stocks.
Recommended Passive / Active Split For The Average Investor
After going through all the different splits above, I say the average investor should have a stock investment split of 90% passive and 10% active and no more than 20% active.
For example, if you have a $1,000,000 stock portfolio, invest $100,000 in individual stocks and $900,000 in index ETFs. Even if you lose all your active investment money, which you likely won't, you'll still be fine.
With the 10%, you can try and pick winners with no expectation that you will outperform. Invest in what you know, use, and earn. Do you really think investing in Apple computer is going to make you go broke? Probably not with its $100+ billion in cash. But you might lose a lot in a Gamestop, an unproven biotech company waiting FDA approval, or an over-leveraged marijuana company.
As you get more interested and more experienced with investing, you can gradually increase your active investing percentage. I wouldn't go greater than a 50% allocation towards active investing. The historical performance numbers just aren't our friends.
Further, remember that if you work at a company and get company stock as part of your compensation, these shares can count as part of your active allocation. These shares could work out very well for you if you work at a company like Apple. Or these shares could hut you if you work at a company like Enron.
Relying too much of your wealth on your career can be dangerous. If your company goes down, not only will your company shares lose value, you may also lose your job.
As an investor, you must quantify your risk tolerance. Once you have quantified your risk tolerance, you should have no problem working for the amount of time necessary to get back to even. If you do have a problem spending that required amount of time, your risk exposure is too high.
My Current Active And Passive Investing Split
Since 1996, when I opened up my first online brokerage account with Ameritrade, my greatest wins and my greatest losses have all come from investing in individual stocks. As a young man, I didn't mind my big losses because the absolute dollar amounts lost weren't very big.
From 1996 – 2009, I predominantly invested in individual stocks. After all, I worked in international equities at two major investment banks. My income was growing and I felt I had an edge.
But after the financial crisis, my desire to make money quickly dissipated because I had lost so much money (-35% in six months).
My desire to protect my capital and avoid experiencing as much financial pain came to the forefront. Further, I had started thinking about ways to escape finance since it was no longer fun.
Today, my split is roughly 80% Passive / 20% Active. My individual stock investments and private funds have outperformed in recent years given they are heavy in tech. I continue to own a bunch of individual tech stocks and other names for the past 15+ years. After a couple years of living in San Francisco, I realized the real growth was in tech, not banking.
Passively And Actively Investing In Real Estate
Owning Bay Area real estate and tech stocks were my main two ways of participating in the long-term startup and tech boom. As I said in a previous post, I was too untalented to get a job at a growing tech company.
Further, my real estate crowdfunding in the Sunbelt/Heartland have performed extremely well. The demographic shift towards lower-cost areas of the country should continue thanks to work-from-home and technology.
Just take a look at the Fundrise returns compared to stocks and public REITs during down years in the chart below. Fundrise is my favorite private real estate investing platform. It offers great diversification and passive income.
Always Going to Actively Invest Some Money
After all these years, I still enjoy following all the economic, political, and company-specific news that could affect share prices.
However, as a dad to two younger children now, I no longer have the time to analyze cash flow statements. Listening to management conference calls is a thing of the past.
I like the combination of having a core S&P 500 index fund, some sector ETFs, and individual stock names that I use and love. It's my “Passive Plus” strategy.
I also sold my actively managed SF rental property in 2017 that was giving me nightmares.
35% of the proceeds were invested in dividend ETFs and single-stock names, 35% was invested in California municipal bond funds, and 30% was invested in a portfolio of real estate crowdfunding projects. It feels great to earn income passively.
My main financial goal in my 40s and beyond is capital preservation. The bull market we've experienced since 2009 has been greater than I had ever expected. Further, I also want to buy as much time as possible. If I can grow our net worth by 10% a year with minimal stress, I'll be ecstatic.
U.S. Stock Market Ownership Is Diversified
There's a lot of talk about passive investing being in a bubble. However, take a look at this U.S. stock market ownership graph. If we say ETFs make up the majority of passive investing, then passive investing does not dominate stock market ownership.
The vast majority of people should still have the vast majority of their investments in passive investments. Passive index investments have low costs and it's very hard to outperform the indices.
Investing mostly in passive funds doesn't mean you should be a zombie and just invest 100% in a particular passive equity index fund. You should diversify your investments to match your specific financial goals and risk tolerance. Review your investments at least once a quarter and also be aware of home country bias.
Find a way to get rich slowly through passive investing. It's also worth finding ways to get rich quickly through active investing as well. It's up to you to find the right split between passive and active investing depending on where you are on your financial journey.
Related: The Best Way To Get Rich: Turn Funny Money Into Real Assets
Please note, I firmly believe in the long run, the vast majority of day traders will blow themselves up. If you are to invest in individual companies, do your fundamental research and invest in what you believe will be long-term winners.
Achieve Financial Freedom Through Real Estate
Now that you have a good sense of the recommended split between passive and active investing, consider investing in real estate. Real estate is my favorite way to achieving financial freedom because it is a tangible asset that is less volatile, provides utility, and generates income.
In 2016, I started diversifying into heartland real estate to take advantage of lower valuations and higher cap rates. I did so by investing $810,000 through real estate crowdfunding platforms. With interest rates down, the value of cash flow is up. Further, the pandemic has made working from home more common.
Best Real Estate Investing Platforms
Fundrise: A way for all investors to diversify into real estate through private funds with just $10. Fundrise has been around since 2012 and manages over $3.3 billion for 400,000+ investors.
The real estate platform invests primarily in residential and industrial properties in the Sunbelt, where valuations are cheaper and yields are higher. The spreading out of America is a long-term demographic trend. For most people, investing in a diversified fund is the way to go.
CrowdStreet: A way for accredited investors to invest in individual real estate opportunities mostly in 18-hour cities. 18-hour cities are secondary cities with lower valuations and higher rental yields. These cities also have higher growth potential due to job growth and demographic trends.
If you are a real estate enthusiast with more time, you can build your own diversified real estate portfolio with CrowdStreet. However, before investing in each deal, make sure to do extensive due diligence on each sponsor. Understanding each sponsor's track record and experience is vital.
Real estate offers great diversification against stocks.
Invest In Private Growth Companies
In addition, consider investing in private growth companies through a venture fund. Companies are staying private for longer, as a result, more gains are accruing to private company investors. Finding the next Google or Apple before going public can be a life-changing investment.
One of the most interesting funds I'm allocating new capital toward is the Innovation Fund. The Innovation fund invests in:
- Artificial Intelligence & Machine Learning
- Modern Data Infrastructure
- Development Operations (DevOps)
- Financial Technology (FinTech)
- Real Estate & Property Technology (PropTech)
Roughly 35% of the Innovation Fund is invested in artificial intelligence, which I'm extremely bullish about. In 20 years, I don't want my kids wondering why I didn't invest in AI or work in AI!
The investment minimum is also only $10. Most venture capital funds have a $250,000+ minimum. In addition, you can see what the Innovation Fund is holding before deciding to invest and how much. Traditional venture capital funds require capital commitment first and then hope the general partners will find great investments.
The Recommended Split Between Active And Passive Investing is a Financial Samurai original post.
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Sam – Since you have wrote this article, how is it working out for you? Has FOMO, higher risk and higher fees beaten out the passive road?
Yes, pretty good thanks. It’s a bull market, so it’s been relatively easier to outperform. There are no fees holding single stocks. How about you?
Agreed, same here with bull market. Index spread: S&P 50% Small Cap: 30% Int: 20%.
If there is truth that a good performing mutual fund cannot beat its index year after year, its it worth it? At the end of the day, nobody really knows who’s crystal ball will work at any given time.
Dang, the average investor makes 1.9%!? That’s sad!
I’ve been investing a little over a year, heavier and 160% in the last 12 months. That’s anything but passive, and I have obviously have benefited from quite the bull market.
I basically track Trends, look for companies that are out performing the general market, also use ETFs, but no options and no index funds.
Investing is hard if you don’t know the crucial parts of how to invest properly. I invest my money through the business market, which I know can give me a huge income. It won’t waste my money on investing. I also suggest seeking href=”https://www.fortitudefg.com/”> professional advice to help you be guided with your financial goals and achieve financial success.
I’m comfortable with a 90-95% passive portfolio. I’m a big fan of ETFs and don’t have single name stocks I regularly follow very often.
Sam,
This is off-topic so you don’t have to approve the post, but what are your thoughts on what is going on with GME and other meme stocks? I have no stake in the game, but I was following all of the articles and even went on reddit to read up on what all the shenanigan was about and I found it extremely interesting. Chamath was on CNBC to talk about this very issue yesterday and he made so many compelling points.
Many brokerages also put on restrictions on buying more GME stocks so this really seems like a David vs Goliath moment. Since you’ve been on both sides of the coin, I’d be very interested to hear your thoughts (perhaps a blog post idea?).
Cheers
I think it’s amazing what’s going on! Like class warfare between hedge funds and retail investors, where the rules change for the big guys.
Hopefully everybody is a mature adult and realizes day trading and investing in such a way can make investors money and lose investors money. Everything is rational at the end of the day.
I don’t recommend day trading and I have a fun post coming up.
With no stake in the game, what is it that interests you most about what’s going on?
It’s interesting to me because I want to see the underdogs win. I’m not sure who’ll be on the right side of history when we look back at this issue with more objective information several years from now, but the little guy can actually win despite the odds stacked completely against him.
If GME’s short squeeze materializes, it might be one of the biggest, unintended transfer of wealth too.
Here you go: https://www.financialsamurai.com/day-trading-is-a-waste-of-time-and-money/
This was a great read, thanks Sam. My current split between active and passive investments is approximately 16% active and 84% passive. I’ve been managing my hobby portfolio for about 14 years. When I started only post tax money was invested in individual issues, such as common, preferred, and bonds. After about six years I started allocating up to 5% of retirement accounts to the hobby portfolio. In 2020 I upped the percentage to 10%. I think the average investor saving for retirement is best served by investing 100% in low cost index funds. For those of us that find investing fun, and are willing to take on some additional risk, I think 95% passive and 5% active is probably appropriate. I suppose one should take this advice with a grain of salt since I am more active than my own recommendation!
Ah, do as I say, not as I do!
Yes, the temptation to take additional risk and trade yourself is strong.. and grows stronger in a bull market when you see so many opportunities and so many people get richer picking stocks.
Yes, part temptation, and part success. Perhaps one feeds the other? :) One of the allocation distortions that has occurred for me is a handful of winners racking up returns that begin to distort the allocation. For me it has occurred over a long period of time.
Close to 75/25. I’m a firm believer in dollar cost averaging into a S&P fund but I love the game to much to go 100 percent passive. My active account I shoot for 5 percent so the bar has been pretty low lately but times change.
I have been getting caught up in the momentum stocks including GameStop and AMC lately and I figure I’ll get burned, but it has been incredibly fun participating. I’m only using money I’m willing to lose but damn it’s fun!!!
Yes, so fun to watch and play (if you’re making money). There are losers, of course, but all investors know this when investing in this type of speculation.
Sam, I’m curious about your thoughts on a value-averaging strategy for passive investing. You probably already know this, but value-averaging is a bit like dollar-cost averaging but you invest more when the market is down compared to a set benchmark. I don’t have any time to actively invest, and I don’t want to pay the fees to hire someone, so I have been investing in ETFs but am timing my cash deposits so that they happen only when the market goes below a certain benchmark. I’ve set my benchmark for 10% growth annually. This requires me to have some cash lying around at all times to make sure I have enough when it’s time to invest. At the beginning of each year, if I have a surplus amount of cash from the previous year due to the market doing better than my benchmark, I add this surplus to the new year’s projected cash savings amount. If I instead have a deficit from the previous year due to the market doing worse than my benchmark, I subtract this deficit from the new year’s projected cash savings amount.
I have practiced this method for 6 years now on a weekly basis, and it has meant that I invested a lot of money for major market downturns. You can see I am contrarian investor. Most recently, when the market hit bottom on Mar. 23, 2020, I invested all the cash I had in ETFs and made a lot of money off of that so far. Because of the amount I made then, my value-averaging formula has told me not to invest for every subsequent week. I am now at 42 weeks of non-investing and counting. So now I have 42-weeks worth of savings sitting in cash, and I’m waiting for the next stock market dip below benchmark. Right now, the formula tells me that with the current market value, I’m way over benchmark for another few months.
Value-averaging has been my own way of actively investing in passive funds by reacting to market downturns. I have zero financial/economics background other than reading your blog and Investopedia, so I have no idea of this is the prudent thing to do, but it makes sense to me intuitively, so I’ve been keeping at it and seeing good results.
Sounds like a good and disciplined strategy to me. Valuations are clearly expensive in the stock market and earnings must rebound by 25%+ this year for valuations to get back to within a reasonable historical range. Otherwise, the stock market will go down.
The key is finding an investing system that works for you so that you are investing over the long term. Too many people are paralyzed without a system in place, and end up just accumulating cash over the years.
For example, back in 2012, I was nervous about investing b/c I had just negotiated a severance. But, I invested in a Dow Jones structured note that provided 100% principal protection and unlimited upside, in exchange for receiving only 0.5%. That structured product gave me enough confidence to invest.
I could have made more just buying a DJIA ETF, but I was too nervous to do so.
Find the system that works for you that matches your risk-tolerance. If you are constantly worried about your investments, you’ve taken too much risk.
Related: A Better Dollar-Cost Average Strategy
Good morning VAE,
I like your logic and have always been a fan DCA. I like your value averaging better. I have been off the playing field for a number of years due to some personal issues. Would you be willing to share some of the specific ETF ‘s you like etc.
Passive investing is the undisputed king of investing strategies. However, I will never stop fortune hunting and looking for good deals and staking a minority portion of my portfolio to play with the markets.
Passive investing has made me richer than if I didn’t do passive investing so I will always recommend it to people.
“Can you share how much money you’re investing? A range is fine too. It’s been my experience that the larger your capital, the less risk you want to take.” BINGO!
In my case, recently retired @ age 62 w/ $2 million in tax favored accounts and $ 4.5 million in brokerage accounts and 0 debt. GOAL = low stress comfortable lifestyle.
Yes, seeing a $4.5 million portfolio swing by $1 million isn’t relaxing, unless it’s +$1 million!
I put my wife’s investments primarily into passive, because she has a lower tolerance for risk, which helps balance my own inclination to try to use what I know to get further ahead.
If I had been born rich I might very well have ended up a dilettante for much of my life. One of my obsessions is following science and technology news. Besides endlessly fascinating me, it also helps considerably in picking stocks, although I seldom buy individual stocks. I usually buy into funds that are concentrated where I believe they will do well. Most of these are active.
But, once that the business opportunity area is defined, I still don’t invest in funds. I invest in fund managers, ones that have a proven record through both good times and bad.
I avoid funds that invest in bonds, passive or otherwise.
Hey Sam,
First time poster, however I have been following your site for ~8 years… I am not a professional investor, however what has worked for me is 20% passive (401K) and now 80% active (rollover IRA and personal). For the first 10 years of investing I was 100% passive. For the last 10 years my split has been ~ 40 passive and 60 active (new money). I have been very lucky with some stock picks that have increased tremendously which is why my active portfolio even though I started much later is now 80% of my portfolio. My goal is to beat the S&P500 consistently. What I have found is that while I do not beat that benchmark every year; when I do beat it I usually beat it substantially 10-20% more. This difference makes up for any underperformance I have had in years prior. I also want to make clear I do not pick my stocks to invest in. I pay a service to make recommendations on stocks. They pick the stocks and I buy them. I have been doing this consistently for ~10 or so years now and over this period of time I have beat the S&P500. Will this pattern continue I have no idea. I will continue doing what I have been doing though as it turned my finances around.
It is interesting how when we are perform, we tend to really outperform the S&P 500 index. Maybe it does make up for under performance, but I’m not so sure over the long run. We’ve had such a good market since 2009, it was relatively easier to outperform.
Can you share how much money you’re investing? A range is fine too. It’s been my experience that the larger your capital, the less risk you want to take.
Hey Sam,
That is correct. We have had a very nice bull market which maybe that is the reason why. I don’t know. I max out my 401k every year which also includes my company contributing so ~27K there. In my after tax accounts I invest ~3-4K a month. So in total somewhere between 63K and 75K annually.
I am still growing my net worth, but I have surpassed the average net worth for the above average person for my age. That was a goal of mine when I started reading your blog.
As far as my stock positions go I do not want any single position being more than 10% of my total stock portfolio. I have a 1 position that is very close and I may need to start trimming it, but I hope my portfolio will remain lucky and continue to grow so that I do not need to trim. I trimmed Tesla and Netflix at one point and both decisions I have regretted. Of course I do have some other companies that I may not have now due to the trim and some have performed very well.
As far as risk goes yes it is a concern. I think of the great investors though like Buffet. Did he ever decide to be less risky? There is a reason why he is worth billions of dollars. He stuck with it. Maybe time in the market is better. I am counting on it over the long run.
We all want to be heroes, but we aren’t. Reading your article helped me understand why I am good at this. I trade very little. I only add to my positions as the stock goes up. This means I’m buying at the 52 week high, but that high will be surpassed by the next high. I never understood why a person buys more share as the price goes down. I dollar cost average as the stock goes up.
Most importantly I learned not to listen to “experts’ WHO TELL ME WHAT TO BUY AND WHAT TO SELL.
You wrote an interesting sentence about finding the next Apple. What is wrong with the the Apple we have?
Hey Charles,
I buy when they go up and I also buy when they go down. I can’t predict what will happen next. I think the point is to keep buying and get lucky sometimes with a pick. I still listen to the service I use as it has done well for me. I do not listen to other noise in the market though. Nothing is wrong with Apple. I currently don’t own any shares. I did in the past, but not currently.
“I never understood why a person buys more share as the price goes down“
If the share price goes down because the market went down, not because of any issue with the fundamentals of the stock itself, the stock is basically on sale, and you get to average down your cost. Seems pretty basic/understandable.
I agree. Prime example was my Chipotle position. I think I bought at 600. It then went down to 500 and I bought some more and at one point was down to 300 or so and again I bought. Chipotle now is 1483 as of today. I pretty good return.
And also possibly ur percentage allocated to each fund. Thank you Rr
Great explanations! I certainly don’t have the stomach for anywhere close to a 50/50 split. Maybe briefly in my 20s when I didn’t have much invested overall and was trying to pick retail winners I liked without doing any of the research or analytics.
I’ve had years where I was 100% passive, but in recent years I typically average around 90-95% passive. I’m a very set-it-and-forget-about-it type of investor.
LOL!!! Great minds think alike.
When I first read the blog title, my first thought was “90% passive, 10% active” primarily based upon the old rule of thumb that you should never have more than 10% invested in your own company’s stock. Not sure whether or not that rule of thumb was a result of the whole ENRON debacle, or the ENRON thing just drove home the point of the rule.
I appreciate your very well thought out categories and agree a 50/50 active/passive split is the most prudent for non professional personal investors who have an interest in potentially outperforming the market.
As for me, at this point in my life (>60, retired ~8 years) I’m perfectly fine with seeing people make way better returns than I do.
“ As for me, at this point in my life (>60, retired ~8 years) I’m perfectly fine with seeing people make way better returns than I do.”
What I aspire to again!
I was really satisfied from 2012-2014, but the bull market kept running. So I went more offensive.
But now, so much is gravy. Gotta enjoy life more!
As a result of firing my financial advisor, I am working to unwind from 20% of my portfolio being invested in individual stocks and the other 80% in expensive mutual funds. Talk about active management!
But my hope is to eventually churn the funds down to 0% and then individual stocks down to 5% over the next year. It is just a huge battle with capital gains and timing when to take them.
I think for me, I want to end up with about 95% passive ETFs and 5% active in the market, and then pivot into real estate a bit more, once my kids are both in school.
What makes ETF investing passive? If you are investing in ETFs and timing your investments, in my opinion, you are active.
Maybe you can help with your definition of passive and active?
Bingo. Every investment decision made is an active one. After that, it’s up to you how much you want to pay attention and manage that investment.
Have some funds in Vanguard Healthcare Fund with a STELLAR long term track record
BRKB my other active fund
For the average investor a 3 FUND PORTFOLIO is their best choice-Total Stock, Total Bond, Total Intl Stock
Yes, if you can’t beat them, join them. I own healthcare stocks too as I see my premiums rise 3X faster than inflation each year. They are minting money.
Back in the ’70s one of my first jobs as a junior at the Bank of NSW was to lodge and record share certificates into a scrip register. Back in the day, companies actually issued a physical certificate to its investors. And this certificate(scrip) was proof of ownership and hence a valuable document, thus requiring a bank safe deposit facility to ensure that.
Now the interesting thing back then, as I recall it, was that all share investors were of an older age without exception. In fact, you could generally describe those who lodged certificates as closer to geriatric than in the prime of their lives as many were already residents of nursing homes.
There were no young investors, certainly no 30 – 50-year-olds just people across all professions easily exceeding 60 years or more.
Times have certainly changed since then. Far more of the population view share investment as de rigueur and the investment industry has morphed into an absolute behemoth of advice and product manufacture. Nowadays a persons investment strategies centre on product selection and the abilities of a third party to guide our fortunes, all for an annual fee of course.
So rather than be self-directed, we place faith in complex asset and manager allocations using past returns as our guide to future success. And only to have those swept aside with a continuous stream of disclaimers. So no matter how thorough the research is that forms the advice we are given, the results are solely for us to accept without equivocation, win, lose or draw.
Back in my scrip register day, age was no barrier to share investment. ‘Passive investment’ was actually ‘buy and hold’. And a dividend stream was perceived as a valuable addition, as you are in fact purchasing into a business and are entitled to a share of their profits. Ongoing costs were nil apart from buying in or selling out.
We seem to have created a complex world where investing is the sole province of experts and sold to us as far too dangerous for an individual to achieve by themselves.
But really is just mixing a number of geographically diverse ETF’s truly diversification, I think not.
So maybe investors should take more responsibility for their own outcomes and design portfolio’s of well developed and established companies that will provide both growth and income over a long term horizon. Quite simply selecting from the top 20 on your local market is a great place, to begin with, coupled with a program of self-learning and eveloping your knowledge. This will allow you to branch into mid and lower cap stocks over time. And creating your own investment plan will also add a great deal of value to your endeavours. All of which is quite simple and easily researched and learnt.
Oh, and study the cyclical nature of markets and your fear of bear markets will evaporate immediately.
Nice article. Average investor here. I’m pretty much 100% passive in the sense that I don’t invest in individual stocks. The only active part of my portfolio is deciding how much to allocate between the S&P 500, small caps, REITs, EM and US Treasuries.
Sam – can’t agree more with this piece. I also live in San Francisco, and I believe we are about the same age and went thru the same economic cycles in our adult life. Day trading was one of the ways I paid for college back in the dot com time. The only difference is I worked in non-profit for some years in South America instead of riding the 10 years of bull market (I got burn in 2000 and 2009). However, I did put all my little money in real estate since 2009. That has paid relatively well, and I am selling my primary home in Berkeley to move to Seattle soon. I didn’t really “engineer” to leave my last job, but covid did it two weeks and I don’t feel bad at all. Now I am thinking if I should take the proceeds from my home in the passive index funds or real estate crowd fund like Fundrise or Equity Multiple. My gut feel is that this market rally can’t last much longer. The main street economy is vastly different than the Wall Street’s. The only thing I am worried about real estate crowd funds is the liquidity.
I, too, want to write a blog about financials. But I am more into the esoteric side of things such as economic history with data visualization. Not sure if that would attract any audience, but I think I will give it a shot.
Btw, tech jobs are overrated sometimes. I am sure you are talented enough to get one if you wanted to.
Hi Sam,
Would you feel comfortable sharing which California muni bond funds you’ve invested in? I’ve recently been putting a lot of money into BCHYX, which has a much better (and tax-privileged) yield than any current CDs or money market instruments, albeit with more risk.
The active/passive split is one of the most important decisions, so an important article. As a professional advisor I target around 90% passive and 10% active. The active portion is not for excess returns but for diversification purposes. Use actively managed funds in less efficient asset classes like bonds and international stocks. Picking individual stocks may be fun, but so is retiring early.
How about combination of S&P 500 index ETF ($SPY)-30% & Nasdaq100 ($QQQ)- 40% for passive part.
And Individual stocks- 30% for active part.
Ok there’s a problem with these ratios. I started out with 50:50 but a couple of individual stocks (tech) have outrun the average index and now comprise 30% of total portfolio value. Combine that with the other individual stocks and I’m now 70 active and 30 passive percentage wise.
So my original capital allocation was ideal for me at the time but should I rebalance back to that ratio?
What if I was 99% passive and 1% active but that 1% skyrocketed?
While I’m a fan of index ETFs, I am a little spooked by how quickly these are growing in size and their less liquid nature. I experienced this firsthand a few months ago with a medium sized smart beta index ETF which took a day longer than I expected to sell my units. It was a buyers market at that time and i was asking very close to market value. I’m not smart enough to understand how index ETFs actually work in the background and I’m not sure how these really behave in a market crash. We often Pooh Pooh the fund managers when they criticise index investing but at the same time part of me doesn’t trust fully a completely automated process and how it would behave in a black swan event.
I’m amazed at how my active/passive rate has changed over the years. I was so aggressive and then one day it just disappeared and I went into maintenance mode. The older I get and the more money I get the less I want to do and be involved and I’m okay with that. Would have never believed it 20 years ago.
Do you consider active investing the same as maintaining a portfolio such as “Muscular / Papa Bear” or Global Equities Momentum? My thought is to segment my investments to diversify across portfolio types…maybe 1/4 in each of these: Papa Bear, Ray Dalio’s All Weather, GEM, and a Vanguard Target Date fund.
I don’t find the Papa Bear and GEM to be overly complicated to manage.
Thoughts?
The percentage in my situation lies more in the idea that I want access to a chunk of my wealth now. It’s a risk thing – the risk of not being solvent enough when I need the money. I accept the possibility of loss on my balance sheet when I see my active funds. But I’d rather have a greater percentage of my savings in the market than in a bank. My passive stuff is all retirement. My active funds are an extension of my savings and can be accessed when needed. So I guess the split (in my situation) would have to be a consideration of many factors, including liquidity needs, market risk and near-term financial goals. Not everything is about retirement!
Hi Sam,
I enjoy your articles about the stock market – thankyou.
I think one overlooked ‘active’ asset allocation occurs when employees get stock in the company they work for. Many tech employees and execs find themselves in this boat
: )
Ah yes, good point on forced active investing. I suspect a lot of new tech IPO employees will be selling stock and diversifying by end of this year and early next year!
I hope they buy lots of SF property. It’ll be good for them, and good for me.
I have only one individual company stock with only 0.25% of net worth in it. But I have a lot of actively managed funds mostly listed funds in the hedge fund/private equity space (it’s hard to invest in this stuff for US investors). Then I also have close to passive funds though no explicit index funds. Then I trade and I make money at trading, though it is still in start up mode. I use systematic trading models that are backtested etc. My idea is to eventually replace my salary with trading income and then retire. Don’t know if I’ll get to that point, but I’m trying. My biggest investment category at the moment though are short-term corporate bonds, where I’ve parked a lot of the money I inherited last year as I gradually convert it to Australian dollars and begin to deploy it.
Great article. After making various mistakes in my 20s, and also losing significant money in the financial crisis, I settled on a diversified, and 100% passive approach based on the ideas in the “permanent portfolio”– basically you divide up your assets 4 ways between gold, stock market, short and long term treasuries. As modern portfolio theory teaches us, the idea is that having multiple assets that are volatile by themselves but have low correlation to each other reduces risk. Atleast over the past 40 years this type of portfolio has averaged a 5% real return, but the best part is lower volatility which basically eliminates sequence of return risks during draw down (i.e. retirement). Although I’m not drawing down yet, I prefer this portfolio for its capital preservation abilities and low ulcer index. In a weird way, it’s also taught me to ignore all the hype and gloom prognostications. Atleast of the asset classes is always being panned, while another is being praised. Doesnt matter; the portfolio grinds out its ~5% each year. There are other variations of this of course, but I think the basic principle of 1/N is a good one and easy to live by.
I can only think of two reasons why you are not doing the 100% Passive / 0% Active –
1. You belonged to exclusive club of 5% of the financial professionals who can be the market consistently over 20 years or greater.
2. You related to or lucky enough to have made an acquaintance with the person in 5% club.
Good luck!
As you can see by the number of people who have stampeded into index investing recently (Michael “the Big Short” Burry) there will be a comeuppance. You correctly analyzed in your JPM Chart the retail investor gets a fraction of what the actual funds make in actual returns. Why? Because these people will sell when markets implode and are likely buying the latest fad right now chasing performance. When i say they will sell, it does not matter if it is a passive or active investment. That 1.9 % return is not prejudiced one way or the other.
My point is that there is a herd mentality going on and these do it yourself people will all get wiped out in index funds one day. The 49% (80% in Nasdaq) crash in 2002, the 57% meldown in 2009, 20% flash crash in 2011 all scared people out of the market at those bottoms. The indicator of your posts and responses to pile in to index funds is bearish signal to keep watch for.
The point you should be making is not what type of fund or strategy to invest in but to concentrate on getting a detailed financial plan to achieve their goals (retirement, college education). I no doubt believe none of your subscribers have any clue of what amount they need to reach to achieve financial independence or put kids through college. They just invest and hope. Outperforming the market is not a financial goal and all the affluent and wealthy understand this fact more than your readers.
You should educate your click followers rather than herd them into an sp 500 index fund where they will surely sell the next down 20% decline.
Happy to hear some suggestions on what to do and what your crystal ball says about the future of the economy and the markets.
How have you positioned your investments? And where are you on your financial independence journey?
Thanks
“I no doubt believe none of your subscribers have any clue of what amount they need to reach to achieve financial independence or put kids through college. They just invest and hope.”
Wow Mr J Paul Getty, please enlighten us with your sure-fire wisdom on how you’ve managed your portfolio and the specific numbers you’ve achieved so we can all fall at your feet in amazement and wonder.
+1
I read Mason’s comment, and was transported back to 1990. The only thing missing was the “index funds are ‘average’, do you really want to be ‘average’?” pitch. It comes from the few remaining ‘advisors’ who steer ignorant clients into load-funds (4.75% off the top?) and then an annual 12-b fee (0.75% for ‘marketing’ and 0.25% for ‘service’ for a total of 1% each year to hold a fund that will underperform the index. Ugh. Thank goodness for the blogging community and sites like Financial Samurai to help educate us ‘invest-and-hopers’!
And of course, nowhere to be found when challenged… Mr. Seagull, fly-in, crap all over everything and leave.
Haha, good analogy.
Good analogy? You have no clue as former professional in industry? You must have just been salesman and still are with your product pushing spam ads on this site.
Paper guy…challenged? Ha. Go read the original samurai article and see where it says what investors actually achieve in results. I’ve already said everything you need to know in my first post. If you can’t figure it out then good luck when you sell into the next crash just like everyone else on here. Those declines were from the sp 500 index so if you think you can hide in passive investing and reach your goals think again. If people acted like excel spreadsheets then no problem, if you invested in an index fund and then opened your statement at 70 no problem….but people don’t do that – they have emotions and make changes when things go awry. Chase performance and make adjustments at the wrong time. Bozos like you and Jaysleazy just from your responses will never make money in the market let alone reach your financial goals cause you don’t even know what you’re aiming for.
I would think and hope the majority of the readers on this site would think of the next “crash” as a buying opportunity, rather than a panic sell. The numbers don’t lie, matching, not trying to beat the market, is the way to wealth (minus entrepreneurial endeavors). This is why I would favor 95/5 split with the 5 trying to make investing fun and exciting but thought of as “house money”
My portfolio is nearly 100% passive investing. I believe in the 100% equity portfolio, with all of it invested in index funds/index ETFs.
I thought this point was a bit funny/wrong:
“…Further, you’re a busy professional and/or parent who has no interest or time in following the stock market. Your expertise in making money lies elsewhere.”
I actually DO have interest and do follow the stock market. It is precisely for this reason that I invest in equities/index funds, as opposed to actively managed funds. It has been shown through much academic research that actively managed funds cannot reliably beat the index over the long-term. I would say my expertise in making money resides in my index fund investing AND elsewhere.
I am that “rational person that would NEVER invest in an active fund that regularly underperforms its benchmark, especially if it charges a higher fee.” :)
Cheers!
Agreed,you might as well go to Vegas and play the tables, at least you’ll get to see a few good shows.
Fundamentally I meet your 75 25 guideline. I tilt to certain market segments or company sizes. I’d guess those tilts are a factor of about 5 to 10 percent points off the cap weighted sizes of those categories. I also have a 5 percent moon shot play portfolio that keeps me from tinkering more broadly.
Sam,
It seems that there’s a correlation between age and amount of passive investing. That itself might make part of a good future article about risk.
For those of you who have both passive and active investments for a while, have your active investments outperformed your passive investments? By how much? If solely based on past performance, should you keep your active investments or convert them to passives?
But what if financial assets & RE suffer a 90% drop and afterwards bounce along the bottom for decades?
Very timely piece. I’m using the end of this long bull market run as an opportunity to adjust mostly out of active (was previously about 50/50). Perfectly happy right now to take some profits and have a nice bundle of cash treading water at 2.5% until there’s a downturn. Then, once the CAPE ratio is somewhat normalized (at least not over 30!) I will add most of that cash to my passive index funds.
Some people will doubtless say that this is market timing, and market timers often miss out on huge profits from unforeseen market gains. That’s true. However, I think you have to go with the style that fits your personality and situation in life. I’m a logical person with a good life who doesn’t want too much risk, so in a post-yield-curve-inversion environment with low inflation and an extremely elevated CAPE ratio I’m totally okay with making a safe 2.5% until that environment changes.
I have the same outlook as you and situation. I appreciate your acknowledgement of “Some people will doubtless say that this is market timing, and market timers often miss out on huge profits from unforeseen market gains. That’s true.”
May I ask where are you parking the cash to yield 2.5%.
Sam, you are leaving out two very important items in my opinion:
1) Leverage – there is none with crowdfunding, it’s like buying a stock or index fund. Your potential return is only based on your actual investment amount versus real estate where you get to leverage OPM. Apples to oranges since most do not have $1.8 million to divvy up amongst passive crowdfunding investments.
2) Crowdfunding unknowns – My own experience with Realtyshares has me anticipating a major loss due to poor due diligence on behalf of their underwriters, and this is one of MANY examples. I feel many more will occur once the economy is in a downward trajectory and with many of these investments spanning 3-5 years or more on term, it’s quite reasonable to expect such. With crowdfunding you are taken for a ride that you “hope” ends well. It may feel today like it’s ‘set it and forget it’ money, but it’s in many ways a gamble hence the returns that are promised. Each time I’ve personally invested using hope as a piece of the strategy, well, it hasn’t been pretty.
With my own hard-earned money I don’t mind being ACTIVE, as nobody else will care as much as you do. I feel much more comfortable with a great piece of real estate that I control, versus handing money to crowdfunding groups who are now showing cracks in their shells with defaults, foreclosures, poor underwriting, and so on.
Just my .02!
Point #1, factually incorrect. The vast majority of equity deals I have seen (100% on crowdfunding sites actually) employ leverage. In fact, in some ways it’s even better, because the investor isn’t pledging their own assets as they would if they bought property themselves.
Point #2, way overblown and generalized. I’m invested with many sponsors via one particular crowdfunding sight, and over half the sponsors have never lost investor capital. Some of these platforms do have a higher percentage of more risky deals, but that’s only a function if investor demand because most people chase high returns. There are plenty of boring ones for people like me, with high likelihood of 12-15% IRR over the long term. Side note – if you fear the Crowdfunding company going under, use a direct model, and not a company branded vehicle.
I have all of my tax-deferred investments in passive index funds diversified across the world and cap size.
My taxable account is 80% passive index funds with the same diversification like above. 15% is dividend stocks that I chose and two actively managed sector EFTs make up the other 5%.
Such helpful and fun descriptions of the various passive / active splits! I fall closest to the 100% passive category. I only have a tiny share that’s active. When I was younger I had a larger active percentage, maybe 25-30% but I quickly realized I didn’t have the expertise, time or patience to make that work so I took some losses and have stuck with passive investments since then.
I turn 62 in October. Stock and stock index funds now make up 68% of our investments, down from a recent high of 84%. Of this, 90% are Passive and 10% are Active, down from about 75%/25%. I’ve decided to take a little less risk now that I am in my 60s and recently began the migration to a bit more conservative portfolio. No one knows when the recession is coming or how long it will last but I don’t want to get caught being too aggressive at the wrong time.
My funds are all passive. I have individual stocks separately that I purchased many years ago. Any new money goes into passive index funds.
I’d like to add there are aggressive passive index funds to that aim to beat the market – e.g., growth index funds which offer diversity and the potential for higher growth in the long-term, which I’m sure people know about. So I have funds there are as well as part of my risk model. Any thoughts on index funds that seek growth?
I was 100% active when I was in my 20s and gradually moved toward more passive. Now, I’m about 75/25. But even the active part of it is mostly passive. Most of that is in dividend stocks which don’t require a lot of activities. I wanted to consolidate our rentals, but it looks like we can’t sell right now. So I’ll have 2 units left. Oh well, someday it’ll be 90% passive.
There’s one fund in the HSA which is active, otherwise it’s all passive. And the only goal is to have enough in our 401ks to retire at 55 if we want to. We have over 10 years to go.
As to the “why” of our strategy. I figured out something was odd with actively managed funds when I was young since my aggressive growth ones kept closing every 2 years for under performance. It was pretty obvious the companies were just sweeping that investment history under the rug by opening new funds. So my experience was poor with actively managed and I’m happy to have passive indexes as options now in my retirement accounts.
In my market portfolio (no physical real estate), 99% is passive via index funds. I do not own any actively managed funds and the 1% I don’t have in index is a flier in one company, which I didn’t really consider active but looks like you would include it in your definitions above.