If you’ve been following my No Dumb Questions series for a while, you probably already know: I am not a fan of traditional, active investing.

Don’t get me wrong. We proactively look after our clients’ needs every day. But when it comes to our investment recommendations, our focus shifts. Patient, relatively inactive participation is preferred. Stop wasting your time and energy trying to run toward the next best investment place to be. Just position your investments across all sorts of global markets … and wait.

Passive Investing on the Rise

Why shouldn’t you try to do better? At least in the U.S., the cat’s already out of the bag: After the costs and efforts involved, you can’t reasonably expect to come out ahead by trying to actively pick stocks. The same goes for trying to move in and out of volatile markets at just the right times. A more passive approach with “boring” index funds has become increasing popular.

In his 2018 Passive vs. Active Fund Monitor, my PWL colleague Raymond Kerzérho wrote that U.S. passively managed funds now represent 37% of the market. In other words, U.S. investors are increasingly replacing their high-priced actively managed investments with index investing. Compare that to Canadian passive funds. While passive investing is growing here as well, they’re currently only about 12% of the total market share.

Does the U.S. know something we don’t?

The False Allure of Active Management

We’ve all heard success stories about how friends, neighbors, famous folk, and everyone in between have made money by piling into cannabis stocks, or cryptocurrency, or whatever the next popular trend is going to be. Why shouldn’t you get in on the action too?

In past videos, I’ve talked about why this sort of active investing will work now and then – probably just often enough to make it tempting to give it a go. But overall and over time, it’s long been referred to as a Loser’s Game. Based on simple statistics, the odds you will win at it are NOT in your favor.

Your Best Bets vs. Efficient Market Pricing

To begin with, it helps to know what you’re up against if you do try to earn more than basic market returns. Technically, “the market” is a plural, not a singular place. But if you think of all of our capital markets as one huge place, it’s a forum where opposing players compete against one another to buy low and sell high. They do so, to the tune of an average $600 billion dollars in trades every day.

As each side tries to buy low and sell high, actual prices tend to end up being among the most accurate estimates available on what is the “fair price” at any given moment. After all, if one side felt they were being ripped off, they wouldn’t agree to the trade.

Counting Jelly Beans

It might help to think of the market as an enormous flea market, where hundreds of millions of buyers and sellers are haggling over the prices they’ll receive or they’ll pay. Overall, that results in relatively accurate pricing. Sure, every so often, you may spot a bargain. But the odds of scoring amazing deals over and over again for decades is slim at best.

This is sometimes referred to as group intelligence and, believe it or not, a simple jar of jelly beans illustrates it well. In his landmark book “The Wisdom of Crowds,” James Surowiecki presented a classic group intelligence experiment. In it, 56 participants offered their own guesses on how many jelly beans were in a jar that held 850 beans. The combined average of everyone’s independent guesses came relatively close at 871. Only one participant guessed more accurately than that.

If you apply group wisdom to the market’s multitude of daily trades, you can see how each trade – each best-price estimate – may be spot on or wildly off. But overall, the market is really good at baking all known information into a relatively fair price estimate, i.e., the price at which most participants would agree to buy or sell the holding.

One Smart Market

In other words, if we look past the occasional strokes of random luck, the market is going to more consistently and accurately forecast prices than you or I can over the long run.

Accepting this reality, your job then becomes efficiently capturing the returns that are already being delivered. As such passive investing is the equivalent of owning that big, huge flea market, and taking a portion of whatever total profits are being made there. If you ask me, that beats having to go up and down the aisles every day, haggling with each vendor, and never being sure you got a great deal compared to everyone else.

What if you actually enjoy bargaining for great deals? Hey, you can still do it. But I suggest saving that energy for your real-life shopping adventures. You can use the profits you’ve made from your “boring,” but efficient investments.

What other No Dumb Questions can I answer for you? Send them to me, and see you next time!