What it means to be a passive investor

You ever notice that nobody calls you passive as a compliment?  It’s usually more of an accusation  like…“you’re so PASSive!”

Passive is one of those descriptors that makes you feel lesser than. You’re less powerful, less authoritative, less in control if you’re passive. If you’re the more passive parent, you’re usually the reason for the “morning rush” fight. If you’re the more passive spouse, you’re super familiar with the “what’s for dinner?” fight. Come to think of it, in the context of interpersonal relationships, passive might just be a fightin’ word! 

But in the context of Personal Finance, the word passive takes on a different connotation. And recently, I’ve stopped trying to grapple with that because being passive investors is our sweet spot. 

Passive Investing vs. Active Investing is one of those debates that can get as heated as Drums vs. Flats [flats for the win, by the way]. It’s not necessarily an either/or, but most portfolios reflect a bias towards one approach or the other. This is one of the reasons why good advice can be hard to find because

results are always relative to the risk, and risk is always relative to that individual.  

The difference between a passive investor and an active one isn’t really a matter of savviness—it’s a choice. Our choice was a reflection of how we prefer to spend our energy. 

For our real estate investments, that means we don’t flip homes. We buy, hold and use a local management company to handle tenant-related issues and payment collection. In exchange, we pay them a percentage of the rent each month. For our investment portfolio, we buy passively managed index funds and we pay a small service fee to cover the costs associated with running the fund. The reasons for this approach were:

Lower fees 

Very few things in life are free, but “actively managing” (aka buying and selling securities) a fund REALLY isn’t free. Every time a transaction takes place, there is a fee attached. That means that even if the fund performs well, it could quickly be eroded by the overhead costs associated with performing well. For example, the fees for our Vanguard Admiral shares are 84% lower than the industry average.

In other words, if my passively managed fund delivers a 7% return with a 0.18% fee (+6.82%) and a comparable actively managed fund delivers 8% at a 1.5% fee (+6.5%), who really won? That may not seem like a huge loss in a year, but in the spirit of the OG Jack Bogle [RIP] compounding fees have the opposite effect of compounding interest over time. 

Transparency 

As passive as we are, we’re still the kind of investors who want to understand how the sausage is made. By using index funds, our money tracks the market. If I’m watching the news and see that the S&P rose 2%, I can draw conclusions about what my money did. For me, this is a version of control that feels empowering. When you opt for an actively managed portfolio, you trade that level of transparency for the promise of market expertise. 

Lower tax burden 

As high earners, we were already near the top of an income bracket. With a buy-and-hold strategy for real estate we also have a great tax shelter.  By automatically re-investing the gains on our stock portfolio, we avoid paying taxes on the growth every year. 

You know what’s funny though? As much sense as those reasons make, I had to do a lot of upfront work to learn how to be a good passive investor. At times, I’ve struggled with the simplicity of it all. Approaching anything passively is the opposite of the advice I had internalized all these years.  If I had a dollar for every time guidance like “you have to work twice as hard to get half the credit” or “fortune favors the bold” has echoed through my head, I would already be retired! 

I had to learn the difference between confidence and competence. I had a lot of confidence that we could be GREAT active investors. I’ve also seen first-hand how that same confidence could distort our level of risk and cause us to make bad decisions. On the flip side, developing the level of competence needed to be an active investor felt like a job. Lord knows I don’t need another one of those!   

I also had to embrace how long the “long game” actually was. I tend to overestimate what could happen in 1 year, but underestimate what could happen in 5. Becoming a passive investor meant I had to imagine life and market performance in 30 years or 40 years. 

Thinking about life in 30 years is scary. It makes me think about my own mortality. It causes me to imagine a life where some of the people I love the most are missing.  Through it, I realized that

if I perceive time as something to be feared, everything that requires it will be seen as a problem. Click To Tweet

That mindset is not only at odds with our investment strategy, it conflicts with our vision for freedom.

My investor sweet-spot forces me to address my long-standing habit of “efforting”, instead of just giving things the time they need. So much of my previous debt was because I was trying to manage my fears by taking action with my money.  My path to financial independence is about unlearning that every chance I get, so I don’t repeat those mistakes.