Why Passive ETF Investing Is Hard Work
The best thing to do is nothing at all.
If there’s one great thing about the 2015 film The Big Short it was the way the idea of conviction was portrayed. The way the protagonists held on to their big bet with an iron grip in the face of everything and everyone that told them otherwise. Their defiance and disobedience felt almost heroic (at least as heroic as already-rich guys get richer can get). But if Wall Street was Goliath, they were David all the way.
The dramatized Hollywood production makes it out this way, but it’d be a mistake to believe that conviction as a trait is reserved only for high stakes, moonshot, contrarian fuck-the-Street types of trades. Everyday investors require mentally-muscular conviction as well. It is possible, that an average investor stumble upon their own Big Short type of opportunity — although conviction here may prove to be more tragic than epic. But interestingly conviction is needed, still, when engaging in hands-off, passive investing. That is, when embarking on the prudent Buffett-Approved strategy of Investing In America or dollar-cost-averaging a diversified index fund like the S&P 500.
Let’s remind ourselves of the merit of this strategy by reviewing a simple fact everyone knows but secretly believes they themselves are excluded from: Humans are bad at picking stocks. Over a 20-year period, nearly 90.3% of actively managed US investment funds failed to beat their index. It’s been repeated time and time again: If Ivy League-educated fund managers who devote their lives to beating the index cannot do it — you probably can’t either. And the argument that institutional imperatives or fund size hinder their return is as strong as a soggy paper straw. The argument fails to account for the fact that you are still bad over a long time horizon.
And if being endorsed by arguably the greatest living investor of our time isn’t enough, there’s also an endless criminal record of pseudo-experiments like having journalists throw darts at a list of stocks, or having goldfish in a tank pick stocks that have proven with embarrassing consistency the thin gap that separates stock picking as a practice and shooting craps.
Over a 20-year period ending in 2019, while an index averaged 6.06% per year, the average investor returned 4.25%. Pretty close, right? No, that is 4.25% before broker’s fees, taxes, a subscription to one of the Motley Fool’s expensive newsletters, and, above all, before the opportunity cost of all that time you spent doing your due diligence and staring slack-jawed like a cow into candlestick graphs on your inane multi-monitor at-home “trading desk”. Those countless hours you could have spent working literally any second job (even ones below minimum wage) or spending time with your family.
The alternative to investing money and time with little return is passive index investing. With this strategy, you will be rich, but just not any time soon. Since it’s so easy to lose, performing at the market level means outperforming almost everyone else monetarily and in the critical measure of net time squandered. The singular requirement for this strategy, however, is that the invested capital cannot be touched at any point in time. Altering the fund in any way risks disrupting the compounding effect. That doesn’t only include withdrawing funds prematurely, but also trying to double dip like investing more during downturns and less during upswings. To sum it up, the only rule to beating 90% of the Street is inaction. So why does inaction require conviction?
The reason can be summed up with the reductive Sociology 101 answer: We live in a society. We still need conviction for a totally hands-off investment strategy because we aren’t isolated and alone. We aren’t Thoreau on Walden Pond. Most of us have friends we like talking to, and some of us have family we are required to talk to. We read the news and for those of us who don’t (whether an active avoidance or a genuine indifference), the news often finds its way to us anyway — through said friends, family, coworkers, the grocery store clerk, or the TV that drones in the doctor’s office waiting room, etc. These are all distractions that tempt us into altering our strategy, a strategy wherein success lies precisely in doing nothing and allowing our money to compound year-after-year, decade-after-decade.
These externalities are great at throwing us off-kilter, at making us doubt our conviction. Investing in indexes might as well be code for: “I’m missing out.” This fear, that everyone else seems to be getting hilariously rich without you is easy enough to make you question whether your strategy is too conservative or unambitious. Booming technologies, rapidly emerging markets, endless options for derivatives, market timing, global macroeconomic events, fire-sale opportunities during downturns, there are a million enticing ideas that appear every second, fed to us because we live amongst others. All great ideas that make us forget how bad we are at picking stocks.
Take one scenario: Thanksgiving dinner with your extended family. There’s always this one brother-in-law-type, the one that brags about so-and-so winners he’s picked and how much he’s up this year. If you don’t have a brother-in-law, substitute with the most irritating family member you have. It goes something along the lines of:
BIL: You see Apple’s price?
You: Last time I checked it was—
BIL: $160… yep… yep…
(BIL staring into your soul, a smile slowly forming)
BIL: Guess what I got in at.
You: …
BIL: Go ahead, guess.
You: Uh, did you get in at—
BIL: $100, yep. Made a clean 60%. And that’s not it…
And
BIL: You into crypto?
You: No, actually I don’t really get it.
(BIL shakes his head with arrogant superiority, maybe even rests one of his hands on your shoulder)
BIL: You gotta get into crypto man. It. Is. The. Future. I put $1000 into some random coin I saw on Twitter a week ago. Woke up with two mil in my account.
Your BIL babbling off about how much fast money he’s made is one of the infinite scenarios where the seeds of doubt are sown. Where you feel you are being left behind. Headlines like the following also do not help: “New York brothers become overnight millionaires after investing in ‘joke’ cryptocurrency” or “Teen Bitcoin Millionaire Erik Finman Dishes Investment Tips.”
The great challenge with hands-off, passive investing is its paradoxical nature. It is an absolute guarantee that you will not get rich quick and it commands you to do absolutely nothing about that fact.
Don’t like your situation? Then… no don’t get up and do something about it. Actually, just stay right where you are and keep your hands in your lap.
It defies every meritocratic convention we have of: work harder = more success. It’s completely unentrepreneurial, an idea that goes against every football coach, Gary V, TED talk, or self-help book we have ever been inspired by. It’s difficult to accept that apathy and amnesia or careless forgetfulness is precisely the most prudent strategy for accumulating capital. It’s even harder to sit by while everyone else seems to be capitalizing on easy, fast money opportunities—sometimes achieving financial freedom faster than it takes you to brush your teeth.
For passive index investing, that resistance is the hard work. The effort to be put in has nothing to do with diligent research, blue-sky creativity, or reading 10-Ks and Qs until your fingers bleed. Instead, it has everything to do with reinforcing conviction. It has to do with managing outside temptations that may alter your strategy and pollute the compounding effect. It is about actively resisting distractions no matter how incredible or breezy they look. Distractions that often come from the people we are closest to (our friends, family, and coworkers), but also the media (Jim Cramer, any financial news site/forum), and finally, commission-crazed wealth managers who have more ways to destroy your money than an incinerator. It’s easy to resist drinking alcohol if you’re stranded in the Sahara. It’s a little harder if you’re at a bar. In today’s world, you are at the world’s largest beer hall in Munich, it’s happy hour, and virtually everything and everyone you know is handing you a drink.
Near the end of the film when the markets began to unravel, we had the deeply satisfying adult feeling of “I told you so.” Our band of fierce contrarians was right all along and it was time for them to eat their cake. At that moment, many were swept by the sheer intelligence and penetrating brainpower those few had in spotting an opportunity everyone else was blind to. How Burry meticulously combed through the individual mortgages inside each MBS. How Baum’s team went down to Florida to investigate the situation for themselves. But to hail intellect would be to miss the central point which made these few stand up above the rest. Their shrewd financial judgment was what led them to the opportunity, but it was solely their conviction that let them cash out. The legendary few featured on screen were not the only ones that saw the opportunity in 2008, but they were the very few that held on.
It’s easy to miss that the two-hour and ten-minute movie takes place over a period of two years. More impressive than discovering the bubble, was how they endured and defied, for more than 730 days, the mocking laughter of bankers, for Burry’s fund: litigation, track-record-wiping losses, and an exodus of redemptions, and for the rest: every colleague, coworker, friend, and family member that had sound reason to doubt them, and held nothing back in making it known they did. The true battle they faced was upholding their conviction not against the market, but against the pressures of the people and the world around them.
It is this same conviction that investors should aspire to with a hands-off, passive investing strategy. Like Baum and Burry, you’ve already spotted the opportunity. An opportunity that will eventually make you rich, one that will have you outperform nearly everyone else. Now comes the hard part, do you have the conviction to hold on? In the face of enticing opportunities, news of overnight tween crypto millionaires, arrogant glances of superiority, unsolicited advice from financial professionals, free steak dinners with fluke-superstar fund managers, and mind-numbing family dinners, what will you do? Hopefully, it’s nothing at all.
Thank you for reading my first article. If you leave a comment or send me a message, I will always answer. My site is: www.markchan.co
