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Common advice given is that if you decide to become an active or passive investor, you should stick with the choice you've made. That you're less likely to be successful if you try to pursue both active and passive investing strategies.

But why is it a bad idea to combine both strategies? For example, passively invest in index funds, but when an opportunity arises where it seems that you'll make a lot of money by actively trading, go with that strategy instead? For example with recent events, people are betting heavily against the S&P500, as we're still in the beginning stages of the coronavirus pandemic as of this writing.

Eric Gumba
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  • If you have the ability to actively manage your investments then you should do it. If not, let the market dictate your return. Most people here will tell you that you can't time the market. My two cents is that it's really hard to beat the market on the way up. But it's not that hard to avoid having your portfolio take a 50% beating (see 2000 and 2008) or avoiding the bulk of the current 30% beating. – Bob Baerker Mar 24 '20 at 20:36
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    That it is a bad idea to combine active and passive investing is not common advice. – minou Mar 24 '20 at 21:00
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    "Common advice given is that if you decide to become an active or passive investor, you should stick with the choice you've made." Can you give some references for this claim? I've never heard this advice and would like to see who is saying it and how they are phrasing it. – David Schwartz Mar 24 '20 at 21:39
  • @Bob Baerker: I disagree. I certainly have (or could easily learn) the ability to manage my own investments, but I have many far more enjoyable and/or profitable things to do with my time :-) – jamesqf Mar 25 '20 at 00:10
  • @jamesqf - If spending your time doing things that are far more enjoyable than avoiding the 50+ pct beatings in 2000 and 2008 or avoiding the bulk of the current 30% drop then go for it. It's your time and your money. Well, for now some of it was your money :) – Bob Baerker Mar 25 '20 at 00:58
  • @DavidSchwartz Sorry I should not have written "common advice". But I do remember reading an excerpt from the Intelligent Investor by Bejamin Graham (or maybe it was an article) talking about the idea of enterprising vs defensive investors. Knowing which category you fall under and sticking with it. That was quite a while ago. The only article that I can find now is this.

    https://www.investopedia.com/articles/basics/07/grahamprinciples.asp

     – Eric Gumba Mar 25 '20 at 01:41
  • @BobBaerker It's trivial to avoid losing money in a downturn. All you have to do is avoid making money in upturns. If you believe you can truly avoid downturns while still benifits from the growth of the market... then you need to be running a mutual fund and raking in the big bucks. – NPSF3000 Mar 25 '20 at 14:04
  • @NPSF3000 - "It's trivial to avoid losing money in a downturn. All you have to do is avoid making money in upturns." What does that nonsensical statement even mean? I've avoided the carnage from the past 3 downturns. For this one, I'm almost trading water (lots of OTM long puts are now ITM, some deep). How are you faring with this 30% market drop. Is it a trivial loss to you? – Bob Baerker Mar 25 '20 at 15:57
  • @ Bob Baerker: You can avoid those downturn losses equally well without doing your own investing. Simply convert your mutual funds to cash shortly before the downturn. Of course doing this really well requires a working crystal ball or equivalent :-) But I would be remiss if I didn't point out that I have lost nothing in the current downturn, because I haven't sold anything. Even if I had, I'm still well ahead of my average purchase cost - and those purchases were initially (that is, ignoring reinvestment of profits) funded by doing things that I found far more enjoyable. – jamesqf Mar 25 '20 at 16:43
  • @BobBaerker my point stands. Are you actually beating an index fund over your entire investing career (in which case, go run a multi-billion dollar hedge fund) or you're simply cherry-picking the 'facts' you want to share. – NPSF3000 Mar 25 '20 at 16:43
  • @jamesqf - Sorry it's so hard for you to comprehend that you don't need a crystal ball to limit portfolio losses. And spare me the rationalization that you lost nothing in this downturn because you didn't sell. Do you think that owners of Enron and Lehman are still saying: I didn't lose anything because I didn't sell? Now that's a concept. Because your position value post drop is above cost basis is another rationalization. A portion of your account value is gone. Every broker adjusts margin borrowability down when account value drops. Why? Because it's an unrealized LOSS. – Bob Baerker Mar 26 '20 at 02:47
  • @NPSF3000 - I'm long retired so capital preservation is my priority. I still seek growth but I don't outperform the index (hedging has a cost), though occasionally I have had an outsized profitable year or two (see 2008-09 when I was net short). So you can thump your chest, knowing that you and the index outperformed me :). To this end, for the past few years I have collared my large equity positions with options. Imagine owning Dividend Aristocrats down 20-30-40% and losing less than 10% ? I don't care how low the stocks go. That costs me nothing now. – Bob Baerker Mar 26 '20 at 02:50
  • Cont: For the past few years I have been buying 10% wide bearish SPY LEAP verticals 10% OTM at a cost of about 1.8% a year. With market gyrations and adjustments, I have been able to whittle the annual cost below 1.0% a year. Do you have any idea what long SPY puts became worth in the past month? I've rolled them down twice, booking the gains. Add the collars as well as some trading gains and this market has "bearly" (sic) dinged my protfolio. So no, they were not cherries picked. They were nuggets harvested. – Bob Baerker Mar 26 '20 at 02:51
  • @BobBaerker "I still seek growth but I don't outperform the index (hedging has a cost),"

    Isn't that exactly what I said?

    "It's trivial to avoid losing money in a downturn. All you have to do is avoid making money in upturns."

    Sounds like we're in agreement.

     – NPSF3000 Mar 26 '20 at 03:37
  • @NPSF3000 - You can try to make this sound like we are in agreement but we're not even close. You've set up a false equivalence, concluding that to avoid losing money in a downturn then you must "avoid making money in upturns". Ceding less than 1% annually in order to avoid most of a downturn is a trade off I'll always make. To me, losing 50% in 2000 and 2008 as well 30% loss over the past month is anything but trivial. So let's agree to disagree. Losing such money is trivial to you and it's far from trivial for me and I can SWAN without any concern for how low the market goes. Adieu. – Bob Baerker Mar 27 '20 at 00:22
  • @BobBaerker "You can try to make this sound like we are in agreement but we're not even close."

    We're in complete agreement. You've traded volatility for fewer returns. This is classic market 101. Whether you do that by using some sort of puts or simply by having a more conservative portfolio - this is trivial stuff.

    Your original claim of 'Most people here will tell you that you can't time the market.' is bunk by your own admission, you admit to having fewer returns due to a more conservative strategy.

     – NPSF3000 Mar 27 '20 at 15:24

2 Answers2

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Common advice given is that if you decide to become an active or passive investor, you should stick with the choice you've made.

No you shouldn't. It is perfectly fine to supplement an active portfolio by passive index funds, or to supplement an index fund portfolio with several carefully chosen stocks.

What is bad advice is to buy lots of various active funds (leading to index returns, because there are so many of the active funds, without low costs of index investing). If you believe in active investing, you should select only a fund or at most two in the same market, having fund managers you can trust.

What is also bad advice is to buy quasi-active funds, funds that claim to be active but don't really take any active risk because the fund manager fears losing to the index return. In this case, too, you pay for active management but get passive returns.

Let me propose a case where you could supplement an index portfolio with some actively chosen stocks. If you, for example, like traveling a lot more than most people. Unfortunately, traveling uses oil, so it might be a good idea to buy stocks of oil companies. Traveling also requires aeroplanes, so it might be a good idea to buy aeroplane manufacturer stocks. You of course travel with an airline, so it might be a good idea to buy airliner stocks.

Or, if you drive a lot with an electric car. In this case, it might be a good idea to supplement your index portfolio with stocks of Tesla and electric utility companies, especially those that produce electricity with fixed cost structure like hydropower or nuclear power.

Let me also propose a case where you could supplement an active portfolio with some index funds: you run out of ideas. Simply said. You have so much money to invest but you can't find any companies where you would like to increase your ownership. In this case, it's perfectly fine to buy index funds. Or, you could hire a monkey to throw darts into a list of stocks to select new investments for you. But it's much simpler to buy index funds than to hire a dart-throwing monkey.

juhist
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Common advice given is that if you decide to become an active or passive investor, you should stick with the choice you've made. That you're less likely to be successful if you try to pursue both active and passive investing strategies.

Do you have a source for this? That advice is so very wrong. It suggests, that once you make a choice you can never ever change your mind.

While it is perfectly fine to be a 100% passive investor almost no one should be a 100% active investor for anything but a trivial portfolio.

We all have specialties. For one person it might be emerging technology and he may actively trade in stocks in that sector. If so, they should probably do their bond allocation passively and perhaps other equity sectors.

A more common approach and more sage advice, for most of us, is that no more than a certain percentage of your portfolio should be actively traded. For me, I like to keep my single stock ownership less than 5%, and my actively managed funds less than 30%. YMMV but having a mix is fine, and being 100% passive is fine. What is not fine is being 100% active.

Pete B.
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  • Sorry I should not have written "common advice". But I do remember reading an excerpt from the Intelligent Investor by Bejamin Graham (or maybe it was an article) talking about the idea of enterprising vs defensive investors. Knowing which category you fall under and sticking with it. That was quite a while ago. The only article that I can find from doing a quick search is this: investopedia.com/articles/basics/07/grahamprinciples.asp – Eric Gumba Mar 26 '20 at 17:00