We Were Born to Win: Passive vs. Active

It's human nature; we were born to win at all costs. Not only are we survival machines, but our fierce competitiveness introduces many different emotional biases that can cloud our judgment in an advanced world when it comes to decision making.

Sports or investing, people have an urge to win.

Specific to investing, investors seek outperformance; we seek superior returns and in effect, more money. While the lottery could be described as a tax on people that are bad at math, one might describe the stock market as an ever changing fertile crescent for confirmation bias: confirmation bias being the tendency to search for or interpret information in a way that confirms one’s beliefs or hypotheses. Humans are very talented at coming up with facts to back hypothesizes, while it should be hypothesizes as a result of facts.

I would like to introduce two financial strategies to you: passive and active.

Passive management aims to replicate the performance of the “market” as a whole. When I say market I am referring to the aggregation of buyers and sellers, the average of what every other investor is doing. The passive investor does not attempt to “time” the market; this could be selling their positions right before the election or the passing of a bill in anticipation of some type of mass pessimism. The passive investor is the stoic of investors: one who can endure pain or hardship without showing their feelings or complaining.

Why is this done? The passive investor has an understanding that their lack of total comprehension of why the market goes up and down will prevent them from making educated investing decisions. However, they believe in “reversion to the mean.” The market will go up, the market will go down, but given a long time period the market will consistently rise. The passive investor controls their fear.

Active investors see themselves as the superior investors. Due to various methods and research techniques, the belief is that there is the possibility of outperforming a given index or market through individual stock selection and market timing. The essence of their approach is to capitalize (outperform) based on pricing inefficiencies in the marketplace.

Individuals utilize the active approach (hire an active manager) to increaser their perceived chances of outperforming the market. Through the relationship they gain researched and informed investment decisions. They also have the possibility of maximizing gains and minimizing losses. It is important to remember that an active investor is different than a financial planner, which covers not just investing, but all aspects of financial planning.

Now let us look at your situation. You are 24, you just landed a job, maybe your first, and you are thinking about investing. Do you need a financial planner? I would say no, but you do need a financial plan. And part of this plan involves deciding how you are going to invest your funds. Once you start saving it can be easy to be deterred, one bad mistake could set you back several years and your optimism about saving may be ruined. My advice to you is to step back from idiosyncratic risk, (risk associated with one company or a small group of them) and buy the market as a whole. Once a solid base is built up, a time or even a need may come for an active manager; however given the extreme value of time, especially in your 20s, the best thing in most situations is to step back from risk, choose a cheap fund, forget about your money and do not pay attention to the markets.

-Luke