What is passive investing?
Unlike active investors, passive investors do not try to "beat the market"; they want their portfolio to look like the market.
Buying ETFs or Mutual Funds provides the following advantages over buying individual stocks.
- Don’t need to monitor the market for daily price movements
- Less time required to analyze companies and stock prices
- Fewer taxes owed with this strategy
- Lower transaction fees if you are not using a broker like Robinhood
The Million Dollar bet
This exciting story of a very famous investor shows the effectiveness of passive investing.
In 2008, Warren Buffet placed a bet against an active investment firm, Protégé Partners LLC, that the costs to a managed active investing strategies are too high.
Terms of the bet: Warren Buffet would pick a passive investment, and Protégé Partners would select top-performing hedge-funds. After 10 years, they would compare the total return after the costs of trading and management fees. The loser would donate $1 million to the charity of the winner's choice.
Warren Buffet chose $VFIAX, Vanguard's ETF that tracks the S&P500, for his passive investment vehicle. Protégé Partners picked 5 funds that they did not disclose.
The unexpected outcome
The outcome had a surprising twist. When Buffet and Protégé Partners struck the bet, they each contributed $320k to buy $640k worth of Treasury Bonds that would pay out $1M in 10 years. This money was meant to go to the winner's charity.
The financial crisis of 2008 caused the bonds to jump in value because investors were buying the same bonds as a safe place to park their money. Their bonds were worth $1M in 4 years, 6 years ahead of schedule. Buffet and Protégé Partners decided to sell the bonds early and put the money into Berkshire Hathaway stock. They would sell the shares at the end of the bet and the total amount, including excess gains, was to be donated to charity.
Warren Buffet was the winner at the end of the bet, and the Girls Inc of Omaha ended up receiving $2.2M, originally intended to be $1M. The money set aside for charity dramatically outperformed both Warren Buffet's and Protégé Partners' choices.
Your investment strategy is your own; however, passive investing is the easiest way to get started. As shown by Warren Buffet, picking a couple of index funds can outperform professional money managers over the long run. You can get started passive investing today by buying a few ETFs and Mutual Funds.