There are two primary ways in which people invest
in the market. A passive investor takes a buy-and-hold
approach, while an active investor will try to sell
in times where the market is thought to be at a peak
and buy again when the market is thought to be in
At first glance, an active approach appears to be
far superior to a passive one. If you sell at the
peak, wait for the market to drop and then reinvest,
your returns would be much greater than if you simply
held your original investment. The problem with this
approach is that no one has the ability to predict
Unfortunately, this inability to reliably predict
the future is routinely obscured by news stories
of people who have had tremendous sudden success
when actively trading in the market. These stories
are fueled by the media’s need to sell copies
and our own natural tendency for greed. News reports
about passive investing and the academic research
supporting it is not usually front page material.
When attempting to beat the market, there is a great
risk of selling before a run-up and/or buying before
a dip. Additional trading costs are also incurred
regardless of the gain or loss of the investment.
In non-qualified accounts, short-term capital gains
are further diminished by the individual’s
ordinary income tax rate, as opposed to the significantly
lower long-term tax rate of 15%.
Passive investing inherently will have fewer dollars
lost to transaction costs, management fees, and taxes.
The difficulty for active management to overcome
these factors has been compared to consistently hitting
a moving bullseye when blindfolded!