Question: Is it better to invest in stocks passively or actively?-EnRich personal finance training participant
Answer: Have you ever seen the classic movie about Wall Street? Well guess what, the title is no other than “Wall Street.” The movie, which came out in 1987, revolved around two main characters. The first is Bud Fox (played by Charlie Sheen), a Wall Street stockbroker with a strong desire to get to the top no matter what. The other is Gordon Gekko (played by Michael Douglas), a high-powered, extremely successful but greedy and ruthless investor/trader. One of the highlights of the movie is when Gekko explains to a large group of stockholders that he is not a destroyer but a liberator of companies. In his speech, Gekko explains that “… greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through and captures the essence of the evolutionary spirit. Greed, in all of its forms—greed for life, for money, for love, knowledge—has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA.”
After hearing or even reading Gekko’s speech, you will probably not have any second thoughts about bashing him on the head. Is greed really good? Well, let’s look at history for answers.
A lot has happened to the US stock markets since the showing of the movie “Wall Street.” From about 1,900 at the start of 1987, the Dow Jones Industrial Average (DJIA) hit a high of nearly 14,200 some 20 years later before correcting to 11,200 in November 2011. The period was marked by a lot of volatility caused by market crashes as enumerated below:
October 1987 crash of Wall Street
Asian financial crisis (1989-ongoing)
Dot Com crash (2000-2002)
Housing bubble and debt crisis (2007-2009)
European debt crisis (2010-ongoing).
The funny thing is that in each and every market crash, the culprit has always been clinically defined as the excesses of investors and traders. In layman’s terms, it is pure and simple greed. Prices of stocks are pushed to stratospheric heights way beyond what the underlying value of traded companies or goods could justify. This was true whether it was for the earlier market crashes like the Tulip Bulb Craze (1634-1637), the South Sea Bubble (1711), Florida Real Estate Craze (1926), the Great Depression (1929) or even the more recent ones. This is the reason why the Occupy Wall Street movement is rallying against the greed that it says has enveloped corporate America.
So have the US and other economic superpowers been better off because of this greed that Gekko talks about? The US is currently facing a long-term structural problem with its $15-trillion debt. The European Union is still waiting for the structural reforms it has put in place to economically stabilize some of its member countries like Greece and Italy. The best estimates point to years before these reforms bear fruit.
Greed, fueled by exaggerated rumors and herd mentality, has led to stroke-inducing swings in the markets. Yet some say there is money to be had in stock investing, and I agree. The only question is would you rather do it the easy passive way or the nerve-racking active way? The common suggestion is to invest in the stock market passively through Peso Cost Averaging, or PCA. This is where you invest a fixed amount of money periodically in a number of stocks of your choice. The theory is that with a fixed periodic investment amount, you will buy a lower number shares when stock prices are high and more shares when prices are low—a great application of the buy low, sell high maxim in investing.
But there is a better way. Why not espouse PCA but by buying into pooled funds that are actively managed. The logic here is that there is more money to be had if the investor buys and sells stocks actively.
Over a five-year period ending in 2010, whether on a simple average of yearly returns, a beginning to end compounded annual growth rate or a compounded annual growth rate on yearly PCA investing, stock-invested mutual funds (as a proxy to actively managed funds) have consistently outperformed investing directly in PSEi component stocks. The strategy makes sense since you as investor can focus on generating savings from your main preoccupation and let the experts do the investing. Moreover, professionals will be more objective and methodical with investing other people’s money and will not be easily swayed by greed, rumors and herd mentality.
So why make investing difficult? Do PCA in actively managed pooled funds, particularly those invested in stocks, bonds or a combination of both. And please remember the other Wall Street saying, “Bulls make money, bears make money, pigs get slaughtered.”
Call (63-2) 216-1541 or e-mail efren@personalfinance.ph if you want to learn more about PCA investing in actively managed pooled funds.
As a final word, greed is NEVER good.
(Efren Ll. Cruz is a registered financial planner of RFP Philippines, personal finance coach, investment adviser and author. Questions about the article may be sent by SMS to 0917-5050709 or e-mailed to efren@personalfinance.ph. To learn more about the RFP program, visit www.rfp.ph or e-mail info@rfp.ph.)