Remember that time in high school when your math teacher gave everyone $10,000 of “pretend” money to “pretend” trade in the stock market? You were probably given instructions like, “Invest in the company (or companies) that you think will do the best”. And while that seems completely logical, investing is not quite so simple (and also, not nearly as complicated as you might think) . Therein lies a huge opportunity for you to better your chances of “winning” when it comes to the stock market.
Whether or not you know anything about the stock market, most of us grow up with an understanding of investing that much more closely resembles “gambling” than actual “investing”. Let us explain.
ACTIVE VS PASSIVE INVESTING
In the finance world, there are two main ways to invest your money – actively or passively. As the names would suggest, active investing employs strategies to beat the market and passive investing only plans to match it. Passive investors believe the market is efficient (read more about the Efficient Market Hypothesis) and very quickly incorporates news, information or expectations into its prices.
EMH coupled with countless studies have shown us that more often than not, highly compensated portfolio managers and sexy hedge fund strategies underperform the market as a whole.
THE ONE INVESTMENT THAT WINS
In 2007, Warren Buffett decided to put his money where his mouth is regarding his passion for passive investing. He engaged a $1 million bet. The terms were clear. He challenged his high profile investing buddies that his single passive index selection would outperform any of their sexy and exciting “active” hedge fund strategies. He [Warren] picked a single index fund: the Vanguard S&P 500 Exchange Traded Fund.
We are 9 years and 2 months into the bet and guess who’s winning?
The four most expensive words in the English language are this time it’s different
-Sir John Templeton.
For those of you who want to learn more about the terms of bet, check out the Brilliant V Boring segment on the Plant Money Podcast.
The point of this story is to illustrate that even the most famous investor believes and has proven that passive investing is the way to win at the stock market.
THE BOTTOM LINE
Stay passive and stay unemotional. Last year, we discussed ETFs in our post, Why You Should Never Buy Stocks Again. Passive investing is not sexy (or very exciting), but it works. As we say at Stash, “buy right and sit tight”.