Posted on July 24, 2009 - by musicwhiz

Passive Investing Versus Active Investing

Photo by mysza831

As one grows older, one’s financial needs change and evolve. Many financial experts and planners have advocated different allocations for one’s funds according to one’s age bracket, and this post is to discuss the options available to one as one ages and nears retirement (assuming this word actually exists in Singapore !). My thoughts had centred on the concept of passive investing, as defined by Benjamin Graham as the “defensive” investor; versus active investing, or the “enterprising” investor. I shall elaborate on the two concepts below and discuss the salient points for each as well as deliberate on the pros and cons.

Passive investing involves methods such as purchasing into index funds or buying blue chips which are “guaranteed” to survive recessions, and in Singapore’s context some examples would be SingTel, DBS and UOB. There is a lot less thought and analysis to be put into such decisions and in effect you are just “buying the market”, or coming close to that effect.

Passive investors do not have to take the time and effort to devote to careful analysis of individual companies, and they also do not need to bother about under or over-valuation as they simply need to pick an index fund which tracks the long-term returns offered by being vested in equities. The idea of “passivity” is further extended to not really needing to keep track of one’s portfolio as one should be reasonably certain of favourable long-term returns, assuming one has not committed oneself during periods of irrational exuberance.

Perhaps there ought to be a disclaimer here: one can only be reasonably assured of a decent return on investment through the passive method if one purchases during a recession or sharp downturn (as we are in now), where general price levels and valuations are low. If one makes the mistake of buying into index funds during periods of irrational exuberance, then it may still take many years before one can break even on their investment; passive though this strategy may be. Therefore, it is critically important for a passive investor to have some rudimentary knowledge of economics and stock market dynamics; as well as some general feel of market psychology, in order to ascertain a proper and conservative entry point. Perhaps some indications can be derived from the sentiments of the general public, where the herd normally stampedes, one may find it wise to act in a contrarian fashion. Note though that this method does not necessarily work for the active investor, as I shall elaborate below. Read more…

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1. Yield Investing versus traditional Value Investing
2. Seven steps to creating passive income from the stock market.
3. Dividend Investing:It matters when you buy the stock