Thursday 10 October 2013

Active or Passive?

In the spectrum of private investors there are those that pick specific stocks - 'active' investors - and those that like to invest in funds that follow an index (such as the FTSE) - the 'passive' investors.

Warren Buffett, no less, thinks that most investors would be better off with an index fund as, left to themselves, they would generally make poor investment decisions. 

Being purely 'passive' doesn't suit some temperaments - certainly not mine! It feels too helpless. And it's no fun. However, much to my surprise, I am slowly becoming more 'passive'. Why?

The 'active' versus 'passive' debate can become quite heated. Retail has a great summary of the case for and against 'passive' investing. There's no easy answer as to whether it is better better to be 'active' or 'passive'.

I've done OK with my 'active' DIY Income Investor portfolio over the last few years, although 2007/08 was a nightmare. As a result, I increased the fixed-income share of the portfolio (with corporate bonds, preference share, PIBs, etc.), in a search for both yield and more stability. That worked a bit too well, and I've sold a lot of the fixed-income securities at a nice profit.

I then realised that the portfolio was over-dependent on the UK market and Sterling, particularly at a time when the UK economy was taking a kicking from a combination of the worldwide credit crisis and outrageous mismanagement of the public finances. My future costs will be mainly in Sterling - but I would like it if my current Pounds are not rapidly devalued.

As I looked to buy assets overseas, the most attractive option appeared to be to use ETFs, which avoided the administration associated with foreign tax rules and also had the inbuilt advantage of diversification. And today, a quarter of my portfolio is in ETFs. Which is 'passive' investing, of a sort, except that it comes with a very definite strategy.

Some 'passive' investors say that they just 'buy the market'. But which market? And in which proportions? Is there such a thing as a total world ETF, including equities and bonds? I don't think so.

We all know now (don't we?) that portfolio mix is one of the most important factors in portfolio performance - the same must surely be true for 'passive' investors. So, there's no floating about on 'total market' indexes for me: the high-yield income-oriented approach seems to worked well so far - and has all sorts of academic support and positive industry research. So the ETFs I buy continue the DIY Income Investor style that I am comfortable with, maintaining a split between equities and fixed-income.

This trend to the 'passive' side is one that I am planning to continue for one very good reason - it is simpler to manage. Once the 'passive' portfolio is in place, re-balancing will be easy - just add to  the highest yields.

Whilst I quite enjoy the cut and thrust of share price movements, my wife doesn't. So when the time comes to pass the portfolio on, it really has to be ultra-simple to manage. In addition, I want to leave a legacy to my children that the Taxman cannot take a big bite out of. There are two possible routes:
  • tax-free Stocks & Shares ISAs, which for good or evil they would be able to plunder
  • SIPPs (Self-Invested Personal Pensions), which have the advantage of having a tax bonus added, but the disadvantage (or possibly advantage?) that the money can only be accessed when they are old  

Both are managed in a very similar way. Clearly, I wouldn't be able to manage either (or both) of the options for ever, highlighting the need for a simpler investment approach.

So, to answer the question I set at the beginning of the post - I am turning to 'passive' investing as it is potentially easier to manage - but I prefer it to be based on a specific strategy - in my case, the search for income.

I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.


  1. "Passive" is not a strategy. It's just running out of ideas. You're just peeved (like the rest of us) that the Initial Post Ofiice was so unfair. Now, we have to figure out what to do with the loot so that it can't be talked down by Milliband. At least review the ETFs again - come on, we are relying on you!
    Any more of this negative stuff and I will stick it all in Skipton PIBS and take up extreme sports.

  2. Passive Income is my favorite business model. That’s exactly how I achieved my financial freedom. One thing about blogging though. Although it’s not a passive income source it can become one at some point.. Cheers!

  3. I find myself being almost the opposite to you. I initially started with a plan to be quite passive but the bug has bitten me and I find myself now seeking growth which is a lot more involved. I can't help but feel that this is a lot to do with me entering the market at a good time and having a certain amount of look so far.