A Case for Passive Investing

I have been an investor for 20 years. My first few years were about active trading and dynamic churn. I believed that I could always find a better stock than what I was holding. There was no harm in selling the stocks which had significantly appreciated. The world was always full of opportunities. I always sold a stock that doubled or trebled. After trebling my money, I never held onto a stock. My portfolio kept changing every two or three years. It looked very different after every four years. The stocks were all new. Nothing remained longer than four years.

Over the two decades, I find that some of the scrips that I sold have done better than the ones that I replaced them with. The aggregate picture is still a strong and satisfactory performance. But, one still can’t help wondering what all this activity and action was all about?

If the first few stocks I bought were simply held on and not churned, I will still have returned as much as I did. In some specific scrips, I would have hit the jackpot. Which made me wonder if I had been busy all these years for the sake of being busy.

The past three years have been relatively passive. I have held onto some ideas despite the implicit short term risks of erosion in valuations. Braving out these erosions has not been easy. But, the outcome has been quite satisfactory. That is putting it mildly.

Going, forward I believe that one needs to think of investment ideas that will keep working for us for many years after we bet our capital on them.

The lack of portfolio churn will surely help in many ways.

1. There is the power of compounding working for you.

2. The incidence of taxes will not impact returns annually. This will further improve the compounding impact on returns.

3. The fallacy of believing that one can constantly find great investment ideas would be fairly dealt with. One would have reconciled with the simplest option of letting a good thing run.

4. DND ( do not disturb ) works best for a portfolio with intelligently chosen stocks. The fact that one will not change his portfolio will put pressure on us to make well thought out choices. You will choose your stocks intelligently.

But, one can’t become a passive investor overnight. If you have always been an active investor, your timeframe in assessing companies would not be longer than a few quarters or at best a year. That clearly means that one’s investment approach needs to be altered drastically if the move from active investing to a passive mode should succeed.

The principal requirement for passive investing is a stock ideation approach where the long term potential of a company has to be carefully assessed. One must definitely think of how a company will perform over a longer timeframe. This requires that the business of the company must be stable and predictable. That means that one can only invest in businesses whose performance does not alter drastically over longer time frames. Obviously, that means that one can’t buy cyclical businesses. Several industries are unsuited for passive investing and need to be given the go-by.

The move towards passive investing involves a holistic change in mindset. The way we think and make decisions would need to change. More importantly, the way we handle ourselves after implementing those decisions is critical for passive investing to work for us. One should learn to think hard and long before investing. And then, one must learn to take it easy.

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