This is a good piece by Rick Ferri on the myth of passive investing. In essence, he notes that we’re all active investors. It’s just that some of us are less active than others. Rick veers towards the less active side and I mostly agree with him there. He says:
“Then I realized, it’s not the actual process of portfolio management that determines if a strategy is passive or active; it’s the goal of the strategy that makes the difference.
A passive strategy attempts to track the market(s), even though it’s understood that market indexes are active themselves. It’s a passive strategy when an index mutual fund’s goal is to track the performance of a benchmark. It’s also passive when an investor selects a fixed allocation to low cost index funds and ETFs and trades these funds to closely maintain the target allocation.
In contrast, an active strategy exists when a fund manager knowingly and willingly attempts to beat a pre-designated benchmark. It’s also active management when an investor or adviser attempts to beat a blended benchmark of appropriately selected indexes. The success or failure of active strategy is always measured on a net-of-cost, risk-adjusted basis against its benchmark.
Pure passive investing does not exist, but that shouldn’t matter to passive investors. When the goal is to be the market rather than beat the market, that’s passive in my book.”
I phrase things a bit differently. When I work with clients at Orcam on designing a portfolio I always try to emphasize that they’re not even “investors”. Technically, they’re savers and when you treat your portfolio as a “savings portfolio” and not an ”investment portfolio” you tend to align yourself with very different goals than the average “investor” who thinks they have to always beat the market or they’re a loser.
I always say that the two primaries goals of portfolio construction are protecting against purchasing power loss and the risk of permanent loss. This does NOT mean you have to play the “beat the market” game. It means you have to generate reasonable risk adjusted returns consistent with the two aforementioned goals. That’s it.
And most importantly, we’re all active to some degree. We all need to rebalance, dollar cost average, contribute new funds, reduce portfolio size, pay taxes, etc. These are all active management techniques of some type. The only thing that’s a truly “passive” approach is a lump sum purchase of a broad aggregate and selling it when you die. Of course, that has no practical application to our actual portfolios. So the entire concept of “passive” investing is a nebulous concept sold by people who are trying to differentiate their business models from others.
The important point is, we are all implementing degrees of active management. It’s important to understand that foundational point and then work to understand whether some approaches are optimal or not. Unlike Rick, I think there’s a place in a portfolio for a slightly more active and more sophisticated risk management approach, but we’re mainly on the same page here.