Passive investing doesn’t remove the need to make choices

I’ve been thinking about the passive vs active debate for a while. There has been a clear shift towards low cost passive investing. Many personal finance bloggers are massive advocates of index investing, some preaching  very high exposure to US equities.  Bloomberg just published “5 ways ‘Passive’ Investing is Actually Quite Active” by Eric Balchuna. The media commentary seems to be shifting from a simple active vs passive argument, to a more nuanced discussion on what passive investing actually is.

When reading about personal finance / DIY investing online, it appears some people think passive investment removes choice from investing. That is, you don’t need to think about, or know anything about investing if you choose to invest passively. This is obviously not true. You need to make important decisions such as:

  1. Asset allocation decisions (e.g. equities vs bonds vs real estate vs cash)
  2. Geographic exposure decisions (e.g. Home country vs global)
  3. Index selection decisions (e.g. S&P 500 vs  S&P total US stock market)

The above 3 choices can have a profound impact on your long-term investment performance. To see the wide variation in 1Y, 5Y and 10Y returns across the 334 ishares ETFs go here.

In summary, passive investing is preferable for most retail investors, but it doesn’t remove the need to make choices.