The Active Passive Debate Rages On

Larry Swedroe was interviewed at IndexUniverse in a opportunity for him to continue his mantra about passive investing over active investing. He made some points that are hard to disagree with but I don't think are necessarily complete discussions of the issues. Decisions need to be well thought out which requires looking at the debate from all sides thoroughly and honestly and then picking what is right for you.

When asked why the debate between passive and active still even exists Swedroe says "it's simply not in Wall Street's interest, because they wouldn't be able to charge you big fees for active management." He goes on to note how much cheaper passive management is. These two points are correct, it is clearly in "Wall Street's" interest and passive is cheaper than active.

Actually it is in more than just Wall Street's interest. I'm not sure that a small RIA firm should correctly be thought of as being "Wall Street," I certainly don't think of our firm as being part of Wall Street but either way it is in my firm's interest and mine that people seek out active management. One aspect of the RIA function is to understand what the client needs, set a reasonable expectation of what can be delivered and then execute against that need/expectation combination. Failure to do would reasonably result in termination. It is in every RIA's interest to retain assets and the easiest way to do this is (repeated for emphasis) execute against the need/expectation combination.

I don't think too many people would disagree with the above, even passive investors. Swedroe would perhaps doubt the ability to execute but not with the need to execute. The big macro is giving people the best chance you can for them to have enough when they need it. Well the need/expectation combination is not really about all alpha all the time it is about what the client needs versus what can be delivered and whether there is a reasonable match between the two. Someone who must get 20% per year without fail regardless of what the market does in order for their plan to work should not hire me. My answer to that person would be save more and spend less, a lot less.

As far as cheaper, index funds are often very cheap but are also used in active strategies by professionals (fee chargers) and do it yourselfers. Owning SPY as the only holding when it is above its 200 DMA and selling when it breaches the 200 DMA would be very cheap and very active. Cheap can be done with active strategies. Using the Schwab ETF (SCHB) would be even cheaper--no commission and a smaller fee. We own SCHB for some clients.

One point he makes that is utterly useless is "the media needs you to tune in to hear what's the best stock to buy and which funds are hot, etc." There is a difference between active investing and speculating and he is blurring the line. Buying RIMM as a guess about an earnings report is not the same thing as doing due diligence on a company like Exxon Mobil, to pick a stock I've never owned, and deciding it is worthy of owning. I realize Bogleheads and the like say there is no difference but I believe there is plenty of evidence to the contrary.

Next nugget; "To me, the evidence is so overwhelming, that, while it's not impossible to beat the market, it's certain that so few people will succeed that it's not worth trying." Beating the market is an incomplete sentiment. All alpha all the time is of course very difficult and of course very few people will do this. Long time readers will have an idea of our results over the long term (specifics become a compliance issue). In almost seven years of compliant track record we've had some years where we outperformed and some years where we lagged but the long term success thus far is mostly attributable not to all alpha all the time but figuring out a couple of very big things to avoid. Some individual years our avoidances, so to speak, were the wrong trade but looked at over a period of years have been crucially important. Going down a lot less than the market, which I identified as a goal before the crisis and wrote about incessantly is not what most people think about in terms of "beating the market" but is very valid as a long term strategy.

Swedroe cites several investing luminaries who say that most people should own index funds. This is correct. But it is also correct that the vast majority of Americans have very little saved and very little inclination to study and follow markets. Swedroe is quote mining (kind of like data mining). Someone with $15,000 should probably own index funds--I put accounts of that size (adult children of clients is an example of this account size) in index funds. Someone with a couple hundred thousand and still accumulating should make an informed decision for themselves about whether or not to use index funds; maybe they should but maybe they shouldn't.

The picture; good friends of ours own a house in Northern New Zealand and that is their view. Joellyn and I went there in 2005 and stayed here most of the trip. They set up the photo for me and while I don't really drink beer during market hours (maybe a mocha instead) it does have the makings for a pretty good day.