How Disciplined Investors Beat Active Investors

By Chicago Partners Wealth Advisors
Charts provided by Franklin Templeton

September 22, 2020

Estimated Reading Time: 8 minutes

How Disciplined Investors Win Against Active Investors

One of the major ongoing arguments in finance is between active investors and passive investors. Active investors use market timing to produce outsized returns, while passive investors take a long-term approach and avoid choosing times to invest.

Research has shown that over the long-term, passive investors have outperformed active investors. To illustrate the power of passive investing, we’ve put together seven quick tips to help investors feel more secure in their decision to hold through the long-term.

1. There are always reasons to stay out of the market

Image

In 2020, we saw an extremely sudden market crash based on the uncertainty surrounding the coronavirus’s impact on the U.S. economy. After a few weeks of volatility, the market righted itself and gained 40% in the following months. Investors were initially hesitant to enter or re-enter the market, or worse - they sold at the bottom and missed 2020’s fast-moving bull market.

Bad news and uncertainty are an inevitable consequence of the super-connected society we live in. There will always be some “catalyst” on the horizon, a danger growing somewhere around the globe, and a CNBC analyst saying “today is the top of the market.” Those sentiments work as well as a broken clock - they are right twice a day. In other words, trying to time the market using information designed to make you fearful is not a long-term strategy for success.

2. Stairs Up, Escalator Down

Image
In February 2020, the market crashed. In one month, we saw losses in the major indexes of greater than 30%. Then, over the next six months, we saw 60% gains. When the market moves down, it moves down relatively quickly. When it goes up, it moves more slowly, with some bumps along the way. But it is moving up, and, overall, has continued to trend upwards since the inception of the stock market.

3. Win the Game by Not Playing

Image

In this case, the “Game” is timing the market. Taking cash out of the market during a downturn to “call the bottom” can seem like a good idea in theory and looks like the obvious move in hindsight. But without a fully-functioning crystal ball, no one knows exactly when the market will hit the bottom.

By missing even one day of recovery at the bottom, the difference in performance at the end of the year is significant. Unless you personally know Doc Brown and Marty McFly, your best bet is to stay fully invested through the down periods.

4. The Best Often Follows the Worst

Image
Staying in the market also significantly increases the chances of your portfolio receiving the “bounce” after the market hits the bottom. The bounce is sudden, unexpected, and upward - and it often comes the day after the bottom. Holding onto your investment hat during the drop pays off when you’re riding the wave back up.

5. Time in the Market > Market Timing

Image
A hallmark of the passive investment strategy is the focus on the long term, but it’s also staying in the market while holding that focus. Year-over-year variance can look especially turbulent. 20-year variance is very small. Take advantage of the average long-term market return by keeping your portfolio well-positioned and invested throughout your investment career.

6. Following the Herd off a Cliff

Image

In August of 2020, Tesla had a run-up of over 80% in three weeks. Word of Tesla’s extreme market performance trickled out of the financial news and into broader topics. With the word going around that Tesla’s stock was performing so well, it drew an influx of brand-new investors. On August 31, an Instagram user shared with her friends that she had bought a share of Tesla, and was surprised at how easy it was to make money. Tesla dropped 33% over the next seven trading days. Time will tell if the Instagram user held onto her shares in the weeks following the drop.

When mainstream euphoria draws more people into the market, it can be a sign of a very natural market cycle of correction and recovery. Staying invested prevents the two portfolio killers: buying high and selling low. Trying to time your entry into the market or selling during a downturn are both tactics that will ultimately fail to increase your overall return.

7. The Power of Persistence

Image Image

Huge drops in the market are unsettling - this is a fact of life. How you, as an investor, react to the drop determines the course of your portfolio’s performance for the year and beyond. We have already seen that trying to time an exit leaves an investor vulnerable to missing the “bounce.” To further drive the point home, staying invested through the drop makes it significantly more likely your portfolio will recover during the year. No decline has been larger than the total annual return - staying invested is key to a successful portfolio recovery.

The passive investor’s path may seem less exciting at times, but the research consistently demonstrates it is the winning strategy. Our investment philosophy is similar - we may add or remove investments to our clients’ portfolios over time, but we are always focused on success over the long term.


Important Disclosure Information

Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.

September 22, 2020

Estimated Reading Time: 8 minutes

How Disciplined Investors Win Against Active Investors

One of the major ongoing arguments in finance is between active investors and passive investors. Active investors use market timing to produce outsized returns, while passive investors take a long-term approach and avoid choosing times to invest.

Research has shown that over the long-term, passive investors have outperformed active investors. To illustrate the power of passive investing, we’ve put together seven quick tips to help investors feel more secure in their decision to hold through the long-term.

1. There are always reasons to stay out of the market

Image

In 2020, we saw an extremely sudden market crash based on the uncertainty surrounding the coronavirus’s impact on the U.S. economy. After a few weeks of volatility, the market righted itself and gained 40% in the following months. Investors were initially hesitant to enter or re-enter the market, or worse - they sold at the bottom and missed 2020’s fast-moving bull market.

Bad news and uncertainty are an inevitable consequence of the super-connected society we live in. There will always be some “catalyst” on the horizon, a danger growing somewhere around the globe, and a CNBC analyst saying “today is the top of the market.” Those sentiments work as well as a broken clock - they are right twice a day. In other words, trying to time the market using information designed to make you fearful is not a long-term strategy for success.

2. Stairs Up, Escalator Down

Image
In February 2020, the market crashed. In one month, we saw losses in the major indexes of greater than 30%. Then, over the next six months, we saw 60% gains. When the market moves down, it moves down relatively quickly. When it goes up, it moves more slowly, with some bumps along the way. But it is moving up, and, overall, has continued to trend upwards since the inception of the stock market.

3. Win the Game by Not Playing

Image

In this case, the “Game” is timing the market. Taking cash out of the market during a downturn to “call the bottom” can seem like a good idea in theory and looks like the obvious move in hindsight. But without a fully-functioning crystal ball, no one knows exactly when the market will hit the bottom.

By missing even one day of recovery at the bottom, the difference in performance at the end of the year is significant. Unless you personally know Doc Brown and Marty McFly, your best bet is to stay fully invested through the down periods.

4. The Best Often Follows the Worst

Image
Staying in the market also significantly increases the chances of your portfolio receiving the “bounce” after the market hits the bottom. The bounce is sudden, unexpected, and upward - and it often comes the day after the bottom. Holding onto your investment hat during the drop pays off when you’re riding the wave back up.

5. Time in the Market > Market Timing

Image
A hallmark of the passive investment strategy is the focus on the long term, but it’s also staying in the market while holding that focus. Year-over-year variance can look especially turbulent. 20-year variance is very small. Take advantage of the average long-term market return by keeping your portfolio well-positioned and invested throughout your investment career.

6. Following the Herd off a Cliff

Image

In August of 2020, Tesla had a run-up of over 80% in three weeks. Word of Tesla’s extreme market performance trickled out of the financial news and into broader topics. With the word going around that Tesla’s stock was performing so well, it drew an influx of brand-new investors. On August 31, an Instagram user shared with her friends that she had bought a share of Tesla, and was surprised at how easy it was to make money. Tesla dropped 33% over the next seven trading days. Time will tell if the Instagram user held onto her shares in the weeks following the drop.

When mainstream euphoria draws more people into the market, it can be a sign of a very natural market cycle of correction and recovery. Staying invested prevents the two portfolio killers: buying high and selling low. Trying to time your entry into the market or selling during a downturn are both tactics that will ultimately fail to increase your overall return.

7. The Power of Persistence

Image Image

Huge drops in the market are unsettling - this is a fact of life. How you, as an investor, react to the drop determines the course of your portfolio’s performance for the year and beyond. We have already seen that trying to time an exit leaves an investor vulnerable to missing the “bounce.” To further drive the point home, staying invested through the drop makes it significantly more likely your portfolio will recover during the year. No decline has been larger than the total annual return - staying invested is key to a successful portfolio recovery.

The passive investor’s path may seem less exciting at times, but the research consistently demonstrates it is the winning strategy. Our investment philosophy is similar - we may add or remove investments to our clients’ portfolios over time, but we are always focused on success over the long term.


Important Disclosure Information

Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.