Passive investing

Burton Malkiel (who is Burton Malkiel) presents in his article for The Wall Street Journal several points for passive investing and index funds in the wake of the financial crisis when many financial advisors or money managers argue that this form of investing (also called as Buy&Hold) has gone.

Professor Malkiel presents a number of arguments that seemingly have to be repeated all over again – there is no one who could time the market for an extended period of time. And if there is someone who predicts the market gyrations in one year the odds are that next year it will be someone else as the markets are random. Moreover, if over let’s say 10 years you miss just a few of the most positive days in terms of returns your overall return for your portfolio will be dramatically less than with a Buy&Hold approach.

Malkiel also argues that the investors regularly buy into the market short before it collapses and they flee short before the takeoff. Exactly the opposite they shoud behave. Just recall the massive inflows towards the end of millenium or how the investors liquidated their positions near the market bottoms in 2002 and 2008. 

According to Malkiel an excellent supplement of a passive investment strategy is the dollar cost averaging and rebalancing. Dollar cost averaging denotes a regular investment of a fixed sum of money. Let’s say you invest 100 EUR every month or 300-400 EUR every quarter. By doing this you can buy more shares when they are cheap and less when they are expensive. In bear markets you accumulate more shares that will work for you when the market eventually takes off.

Rebalancing means keeping your asset allocation consistent with your original allocation. As the time goes your equity portfolio will depart from your original allocation since the odds are that equities will appreciate quicker than bonds. When you rebalance you sell the asset class that (in our example equities) rose above the original allocation and buy the asset class that dipped below it.