The Case for Passive Investing


You can characterize the nature of the stock market like this:


  1. The market goes up in the long run (10+ years).

  2. The market is totally chaotic and unpredictable in the short run.


This suggests that there is only one investing strategy that makes any sense: Buy and hold for the long run, preferably in a way that's low cost and tax efficient. (This is heading towards a sales pitch for low cost index funds.)

If you try to beat the market instead of just riding it upwards, then your odds of success go down instead of up; that's because you'll be missing out on the upward trend (#1) and merely gambling (#2). And if you pay somebody to try to beat the market for you, then the odds get that much worse.

(To take a crazy simile, the stock market is like an escalator. If you want to go up, just get on and stand there! If you try a different behavior, such as hopping up the escalator on a pogo stick, then you'll seem eccentric and your odds of a safe arrival will deteriorate. You want to ride the stock market upward, not try to beat the market.)


Anecdotal Evidence

You can't really prove that it's impossible to beat the market (because you can't prove a negative), but the anecdotal evidence seems convincing. Here's one example, from an excellent conversation (it occurs at the 59 minute mark):


"Fidelity had done a study as to which accounts had done the best... And what they found was the accounts that had done the best... were the accounts of people who forgot they had an account..."


Slow and steady win the race... ignorance and sloth absolutely crush it.


You Can't Buy Skill

Trying to find an expert who can beat the market for you is a losers' game, with bad odds. Just a few articles are enough to tell the tale:


The Motley Fool:

"An eye-opening new study from Standard & Poor's reveals that the majority of managed funds fail to outperform simple index funds... Over the five years ending in mid-2008, the S&P 500 beat 69% of managed large-cap funds. The S&P mid-cap index, small-cap index, and global index also outperformed the majority of their managed counterparts."



"... the typical fund and the typical fund manager pretty much matches up with the index that most closely is related, or matches, with the fund. That's true for domestic stock funds, international funds, fixed income, and so forth." ...What they're not able to overcome, in the aggregate, are the underlying expense ratios. So about two-thirds of fund managers will underperform over a long period of time."


And from a video of Benjamin Graham:

"...you have your choice between tossing coins and taking the consensus of expert opinion, and the results are just about the same in each case... whatever [investment experts] know is already reflected in the level of stock prices pretty much..."


The conclusion:


You probably can't beat the market. But you can definitely participate in it, and enjoy your fair share of its gains, by using low cost index funds and a long term buy-and-hold strategy.




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