Passive investing using low-cost index ETFs and mutual funds is rising in popularity. The number of investors who are excited by the idea of couch potato investing is growing every day. However, in a recent conversation I had with Canadian Capitalist, he observed that enthusiastic couch potatoes usually don’t really invest passively. Sadly, I have to agree.
Let me start by admitting my own transgressions. It took me many years as a stock-picker before I finally decided that I was better off investing passively. Even then I took my sweet time selling off individual stocks and buying low-cost broadly-diversified ETFs. I still hold one individual stock (Berkshire Hathaway) for less than 10% of my portfolio. I don’t intend to ever buy more Berkshire, but this is still a deviation from index investing.
So, I’m not a pure passive investor. But, even if we adopt fairly lax standards for what constitutes passive index investing, few self-described couch potatoes meet the test. Following are 3 categories of not-really-passive investors that I’ve seen.
Stock Picker on the Side
These investors have most of their savings invested passively, but keep 10% or 20% in a side account to scratch their stock-picking itch. The trouble is that in this smaller account their annual stock turnover might be 100%, 300%, or more. This frequent trading usually leads to losses, and replenishing side accounts takes savings away from the passive part of their portfolios.
Dividend Investor on the Side
The idea of collecting fat dividend cheques is irresistible to some investors. Fortunately, most dividend investors hold their stocks for long periods. They usually suffer from too much stock concentration, but adding some dividend stocks on the side of a passive portfolio is likely to be the least damaging of the three types of not-really couch potato investors described here.
ETF Market Timer
I’m always baffled when an investor listens to my short pitch for passive investing and responds with something like “I love couch potato investing. I’ve been doing it for a couple of years. Do you think the stock market is overvalued right now? I sold out of XIU and VTI a few months ago, but I’m wondering whether now is the time to get back in.” These people just won’t believe me when I say I have no idea where the market is headed in the short term. They are very far from being couch potatoes and their long-term returns are very likely to fall a long way short of market returns.
On average, any deviation from pure passive investing is likely to lose money. There will always be those who manage to beat the market, but more will lose to the market.