The Reasons for Using Passive Investing Strategy

My Passive Investing Portfolio

Both my cash and CPF are invested into passively managed portfolio using Permanent Portfolio strategy. I am able to justify investing with passive portfolio because i have studied this strategy in depth, though about the potential good and bad points, and conclude the risk reward of this portfolio is suitable for my investment aim: preserve capital, reasonable growth, no need for market timng, stock picking and company research, and no need for constant monitoring. The final aim is to grow my investments into the millions to secure my retirement. Having financial security and independence along the way will be nice too.

 

My CPF portfolio is 30% STI ETF, 30% 30-year S'pore Govt. Bond, 30% CPF Cash, 10% Gold ETF, to be rebalanced yearly - all bought at once using multiple brokerage in April this year. Total returns including cash interest, for last 6 months, is about 4.25%, not bad for half year of doing nothing. My cash Permanent Portfolio portfolio started off from February to April this year with 25% equal split of STI ETF, UOB Gold savings account, 30-year Singapore Government Bond, and cash, and is having similar returns as the CPF portfolio now. This is not a bad start for me, as being able to make some significant profits without me having to do much managing of my portfolio is much better than having the cash sitting in the bank or having a stranger 'manage' my investment capital with dubious results.

 

Self-learning on Passive Investing

Do be careful and learn any investment strategy well, to know the pros and cons and whether the risk and returns meets your investment objective. Good thing is passive investing does not need much talent to learn and implement. If you wish to learn more about passive investing, do read on.

 

To start off your learning, read this to know what a basic passive portfolio investing is about:

http://andrewhallam.com/2010/10/singaporeans-investing-cheaply-with-exchange-traded-index-funds/

This is basic stock index ETF+bond passive portfolio - personally i think this portfolio is ok and is simple to implement, though IMO this 2 assets is not diversified enough for me.

 

Next, read this about more diversified passive portfolio using Permanent Portfolio Strategy:

http://earlyretirementextreme.com/wiki/index.php?title=Permanent_Portfolio

This uses 3 highly volatile assets'stock index ETF, long govt bond, gold' and low volatility cash to create a overall low volatility portfolio. You have to learn about why people such as fund managers invest in govt. bonds and gold, in order to have confidence to invest with Permanent Portfolio strategy. As the saying goes, do not invest in something you do not understand. I'll admit long bond and gold may take people mroe time to learn and use comfortably, though the rewards of understanding how these 2 assets can be used is probably worthed it.

 

Then you can go explore this blog for ideas about local implementation of Permanent Portfolio passive portfolio:

http://singapore-permanent-portfolio.blogspot.sg

PP strategy is also widely explained in the Internet.

 

Which ever passive portfolio strategy you use is up to your comfort level. The main things about passive investing is choosing asset allocation, yearly rebalancing and keeping long term running cost low.

 

Advantages of Passive Portfolio

I will highlight advantages of passive portfolio here:

-No need to monitor portfolio consistently, or pick stocks, or market time entries and exit - this removes a lot of human errors.

-Lower maximum potential loss in major market downturn, due to bonds prices rising during stock market downturns.

-Near market bottom, there is potential to sell off bonds that are doing well to buy cheap stocks in larger quantity.

-Force investor to be contrarian and buy assets when they are cheap and sell expensive asset to realise profits. Eg. buy cheap bonds when stocks are going up, buy cheap stocks when stocks has had a bad year.

-Long term returns of passive portfolio is similar to that of pure stock index ETF.

-Stock/bond portfolio has lower risk compared to pure equity portfolio.

-Aim of passive portfolio is for reasonable 'market returns', not for 'beating the market'. IMO, in general, expected long term returns for a passive portfolio should be around 7%~10% per year.

Cons of passive investing strategy?

-When stocks prices are soaring in bull markets and people with pure stock portfolio are saying how they are making above 40% returns, passive portfolio with its decreasing bond prices will make less returns at say 20% only - so no bragging rights of very high wins for passive portfolio holders. IMO this is not a disadvantage, because the maximum loss and gains of passive portfolio are both lesser. So passive portfolio holders suffer less and are more likely to stick with their passive strategy during market downturns.

 

Effects of Big Capital Losses

Regarding stock market losses, I will quote from this article:

http://moneymatters.sg/stocks-it-is-when-you-sell-that-matters/

"If you are to look back at past trading trends, you would realize that in a bear market, stock markets typically fall by over 50%. In Singapore, the STI fell from 2,500 points in 1996 to just 800 points in 1998, representing a 68% fall. In 2000, STI fell from 2,500 points to 1,200 points in March 2003, representing a 52% drop. And in 2007, STI fell 62% from 3,900 points to its lowest of 1,456 points in March 2009."

 

Seems like recessions can happen 2 to 4 years after the last recession has ended? I am not predicting that we are due for a recession in 2013, and I am not saying that the stock market will be in a 10 year bull run till 2019. I cannot predict market future like that, and most people cannot predict market conditions in future accurately and consistently also. I can only say with confidence that each investor will meet with severe recession eventually and each investor is better off having a simple workable contingency plan to avoid losses and preserve capital during economic downturns.

 

During such recessions as described above, will you stick with your investing strategy when stock markets just keep on dropping towards -10%, -20%, -30%, -40%, -50% or more? Note that in these recessions, your job security in that job you love may be threatened, or you may have suffered a pay cut or retrenchment, or someone in the household may have lost job and you have to pay for more of the bills. In such low moody and unsure environment, how many percent of paper loss in your investment do you think you can mentally take before deciding to cut loss and preserve your capital to tide over the crisis? Not to mention, possibly seeing your 40% paper profit in shares becoming -20% loss or so is such a demoralising event.

 

Ultimate Passive Investment Aims

In passive investing, the one of the ultimate aim is to preserve capital and not lose too much when market is bad. When your losses are smaller during recessions, in the subsequent recovery period you need less profit in order to recover the loss. Take for example an investor in pure equity took a 50% loss during recession - subsequently he had a 60% profit in the post recession recovery period. Did he do well enough? Not really: (100-50)*1.6=.80%, meaning, he still suffer -20% loss even after having a fantastic 60% gain. Now look at a passive portfolio investor owning bonds in the portfolio. During recession, perhaps the portfolio went down by 20%, and in subsequent post recession recovery period, his investment gained 30% only. How has this passive investor done? (100-20)*1.3=104%. This passive investor has managed to recover his portfolio more quickly and completely during the post recession recovery period of high stock growth.

 

Therefore, a pure equity investor had to endure large paper losses during recessions, or else market time to get out before recession and get back in after recession, while noting psychology plays big part in market timing and most people cannot market time correctly. On the other hand, a passive investor can ride out the economic turmoil more calmly knowing the portfolio strategy is on the investor's side to reduce volatility, preserve capital, and allows disciplined investing. So the lack of very high rewards and corresponding lack very high risk in passive portfolio is actually an advantage from several different perspectives.