Active Investing or Passive Investing? Does It Matter? (Audio Podcast)

December 21, 2019

On this episode, Karl Eggerss welcomes Casey Keller to the studio to discuss active investing versus passive investing.  Is one way better than the other?

Karl Eggerss:                      Hey, good morning, everybody. Welcome to Creating Richer Lives, the podcast. My name is Karl Eggerss. We thank you for joining us. As always, just a reminder, is our website.

Ton of information on there. We’ve got all types of articles from a lot of Covenant folks. We have podcasts, we have TV interviews, radio interviews, all with a bunch of information that we hope can help you make better investment decisions or answer some questions you may have had, so that’s the goal of the website. Our telephone number, 210-526-0057, and the podcast is brought to you by Covenant. Lifestyle. Legacy. Philanthropy..

Again, Hey, in just a little bit, we’re going to talk about active investing versus passive investing. You’ve heard a lot about it in 2019 especially. We’re going to bring Casey Keller, Chartered Financial Analyst into the studio to discuss which one’s better if either, but before we do, interesting week in the market as we saw new highs reached again for the stock market, and it was on a week where we saw the President impeached. I had been asked on some different media outlets the last couple of months what I thought a potential impeachment would do to the stock market, and I said that I didn’t think it would do anything to the stock market, and that’s what’s happened because the stock market is, number one, bigger than that. There are bigger issues, such as interest rates, the economy, profits of companies, trade, and a lot of those things are kind of going the right way in the short-term here, and so the impeachment, and ultimately what happens with an impeachment, what happens to the President, and most believed nothing, so therefore, it was a non-event for the stock market this week.

Kind of baffled some people, but this is something we’ve been saying the last several months. What we do see going on, and again, kind of the, as we wrap up the end of the year, the biggest, if you could really isolate the difference between where we are now versus a year ago, it really is that the economy, what was looking to be slowing down and maybe slipping into a recession, the risks were moving up, the yield curve got inverted, and the fed was trying to lower rates after they were going to … They were raising them in 2018, and they were trying to lower them as quickly as they could to prevent a potential recession, and they look like they may have succeeded, but at the end of the day, we went from potentially three rate hikes in 2019 to three rate cuts, and the economy may have come in for a smooth, soft landing where it didn’t ever recess. Now, some are still saying we are still going to, and I would say yes, at some point. I can’t tell you if it’s 2020 or 2030.

Recessions are normal, so we will have one, but we didn’t believe that we would have one in 2019, and we didn’t. We did say that it was going to be close and we weren’t having a slowdown. We saw that. There was a lot of evidence of that, but the fed lowered interest rates, the economy didn’t collapse, we’re actually seeing some really good things in the economy. Some mixed things still, but still a good economy, a good jobs market.

The housing market has been improving quite a bit. You put all that together with an easy fed, and you have new highs. Now, as we enter next year, we need to watch for, yes, the election. The election will be coming up in 11 months or so, and we will likely see some volatility. This is the time to start thinking about, “Have you been cheating on your portfolio?”

In other words, do you have an allocation, and it got out of whack because the stocks have done so well, and you’re now out of balance, and you want to stay in those stocks because they were doing so great and you’re making money, but you need to be true to your long-term allocation, your long-term plan so you might be needing to rebalance and trim some of the stocks, mutual funds, ETFs, and rebalance into some things that maybe haven’t done as well? Now, I would caution you, here we are, December 21st. You can wait until January second to go in and reallocate in terms of locking in capital gains, but look at the IRAs. That’s nothing you have to wait on, so you could be doing some rebalancing right now, where you do it and how. That’s your specific situation. Of course, we can help you with that if you needed us to. 210-526-0057, and that’s what we’ve been spending some time doing.

This is the time to tax-loss harvest, which we discussed a couple weeks ago on the podcast, but that’s also a time to look forward to 2020, what’s it going to bring? I don’t mean what’s it going to bring for you to sit there and try to predict and make massive changes to your portfolio, but you need to be thinking about, if volatility comes back or when it comes back, which it will at some point, are you going to do anything then about it or are you going to not do anything then about it, or are you just going to say, “You know what? I have the allocation that I should have right now”? What are you going to do? Start thinking about that now while the times are good, because they won’t always feel this way. Remember how bad you felt last Christmas Eve when the markets were sitting at 20%, a drop of 20%?

That was the time to say, “I got to jump in the deep end, and I got to go buy some stuff. I got to go buy some stocks because they’ve sold off.” We may be on the other end of that right now, where you need to be trimming a little bit, potentially, again, depending on your situation, and it doesn’t mean when you sell stocks, or mutual funds, or ETFs that you necessarily need to be parking in cash. It could just mean that you need to take it from an area that is extended, overpriced, what have you to another area that is a little cheaper, a little better bargain, and so not suggesting to sit on the sidelines, but if you did build some cash, it’s not the worst thing in the world. We have a little bit of euphoria right now.

It’s not the type of run we saw in January of ’18, almost two years ago when the tariffs were first announced, and that was kind of that huge run-up into that, and then the word tariff was introduced, and down we went. It’s not that type of run-up, but it’s a pretty persistent run-up right now. It’s a … The market is, it’s not going up dramatically, but it’s going up pretty consistently almost every day, and so let’s watch as we move into the New Year, so really examine your portfolio right now, but you can’t have a portfolio in isolation without having a plan of where you’re going to go, and so that’s what we’re going to be talking about today in regards to active versus passive and your portfolio. All right.

As I mentioned earlier in the podcast, we have an in-studio guest, Casey Keller, Chartered Financial Analyst, who is another team member here at Covenant. Casey, welcome back to the podcast.

Casey Keller:                      Thanks, Karl. Glad to be here.

Karl Eggerss:                      Earlier in the year, probably sometime in the summertime, Michael Burry, who of course was the famous hedge fund manager who really bet against the housing market, and there was a movie based on him. He was a doctor, turned hedge fund manager, and super brilliant, eccentric kind of guy, and made a lot of money. He was early, betting against the housing market. He actually invented securities to benefit when housing prices went down, ended up making a ton of money, and he’s been kind of quiet the last few years, but he popped up earlier in the summer and was talking about that there was a bubble in a particular area of the stock market, and he was talking about active versus passive, and a lot of people didn’t really understand what he was talking about necessarily, and we’re not even going to try to decode it, but we did want to discuss today, does active versus passive even matter? The point of the conversation is most people …

We’ll kind of set the table here. Most people, when they think of active investing versus passive, they really are … I think most people think of trading versus buying and holding. Active means, “I’ve got to do something,” “I’m taking profits,” “I’m putting stop-losses,” “I’m generating lots of taxes and transactions,” and passive, “I’m just going to buy it and set it and forget it,” like the-

Casey Keller:                      Buy and hold.

Karl Eggerss:                      Yeah, buy and hold like the rotisserie chicken guy, set it and forget it, but it’s not really about that, is it? I mean, there’s more to it than that, and then we’ll kind of get to where, I think this will lead us, which is, does it really matter what you call it or what it is? In your mind, I mean, I described it as kind of active versus passive, meaning how much you do versus not, what’s your kind of definition when you think of active investing versus passive investing?

Casey Keller:                      That’s a good question, and I think those terms are thrown around all over the place in the industry, and in literature, in articles, and on TV, and so it creates a lot of confusion, and there are …

Karl Eggerss:                      Right.

Casey Keller:                      Yeah, I think it can be used in different contexts, but I think that one thing that comes to mind right off the bat is kind of this emergence of index funds or ETFs, a lot of times are considered passive funds because there’s not a manager selecting the underlying securities in that fund. You’re buying an index fund, which means you just want to own whatever that index is based on, for example, the S&P 500, versus a mutual fund or historically, a mutual fund where their job was to try and beat an index like the S&P, so you would have a manager that would buy securities, and if their job was to beat the S&P 500, they’re not going to buy all 500 securities. Maybe they buy 50 or 100 of them, and they think it’s the 50 or 100 that are better than their other 500 or they’re the best 50 or 100 in the index so they can outperform, or they buy the 500 and weigh them differently, or some way, they’re making a bet versus an index. That’s one thing that comes to mind, as another way of people look at it.

Karl Eggerss:                      What’s interesting is if you as an individual buy an exchange traded fund for example, it’s a low turnover index, no manager, you’re still doing something. You are being active by purchasing that particular one versus another one, so I guess my question is, “Is there anything that’s really is passive?” Like, “What is passive investing at the end of the day?” Right? You have to be active to a certain extent.

Casey Keller:                      I think that’s a great point, and I think that you can buy the S&P 500. That’s the only thing you own, I believe you are making an active bet because the S&P 500 is just 500 stocks. There’s thousands of stocks worldwide, and of course, globally, so the S&P 500 is just the U.S. stocks and-

Karl Eggerss:                      But you’re also making a bet to buy stocks, right? What about bonds? What about commodities, real estate? You’re making an active bet to even do that.

Casey Keller:                      You are. Yeah, I mean, it’s active in that sense. It’s active that, and not only the S&P 500 is the top five stocks and it make up 16% of that index, so you’re really betting on to some degree, or a large degree, those five stocks, the FANG, the Facebook, Amazon, Netflix, Google and Microsoft, and those make up a big part.

Karl Eggerss:                      Yeah.

Casey Keller:                      You are, maybe indirectly, you may not even know you’re making an active bet, but you are, versus if you own say a global index or like you said, bought a fund that owns real estate and maybe commodities and other … They may have more diversified type fund.

Karl Eggerss:                      Yeah. I mean, I think I know what Michael Burry was trying to get across, which is that there are probably a lot of people in this country, especially that own things that they don’t really necessarily know they owned because they’re massed in a mutual fund, or they’re massed in an ETF, or it’s a fund of funds, in other words, it’s a target date fund, for example, a lot of 401(k)s have the 2035 fund, the 2045, which is really just 10 mutual funds inside one, nice package. We’ve talked about the pros and cons of those in the past and they’re fine, but you’re still making an act of bet, but what he’s talking about, I think is that they’re blindly putting money into something and they don’t really know exactly what it is, and it’s a fairly crowded trade, where is there’s certain stocks that may not be included in those funds that are being kind of left behind and maybe that’s where the value is. I don’t know. Again, there’s a lot of debate what he meant by that and really, I guess the reason I wanted you to come on was does it matter?

I mean, at the end of the day, we’re all having to make a decision about how to put a portfolio together. What you call it active, passive, whatever, I don’t know if that really matters.

Casey Keller:                      It may or may not. I think what Dr. Burry was getting at is that if you … There’s been this movement towards low cost index funds, and so a lot of folks have been buying into that with the premise that they’re low costs, and so that’s better than mutual funds, and that’s the thinking, and so if I can buy the S&P 500 index fund versus a manager that buys large cap stocks, I can do it cheaper and they’re not going to outperform anyway, so there’s this mindset of doing that, and so what’s happened is people are doing that and they’re going, “It’s cheap, and not only that, guess what? It works. It’s been working the last few years,” and so it kind of perpetuate itself, so people are going, “It works.”

“It’s been outperforming and it’s very cheap, so why would I ever do anything else?”, so it becomes as good idea and it’s kind of like what Warren Buffett said. He said, “The biggest mistakes on Wall Street are not from bad ideas. It’s actually from good ideas that are taken to an extreme,” and so I think what Dr. Burry is suggesting is that this may be a good idea on paper and it sounds good, but it may be getting taken to an extreme because everybody’s doing it, and everybody’s going, “This is a great idea because it works and it’s cheap, and everybody does it.” They could be piling on and they are essentially. If you’re buying a bunch of low cost index funds that are investing in the same thing, you’re effectively making an active bet.

Karl Eggerss:                      Active bet, yes.

Casey Keller:                      Yes.

Karl Eggerss:                      Again, I started the conversation by saying we weren’t going to dig into what he meant, and here we are, but to me, it all boils down to you are always making an active bet, even if you’re doing passive investing.

Casey Keller:                      Yeah.

Karl Eggerss:                      Having said that, it really goes back to the financial plan. In other words, a 68-year old who just retired’s goals are going to be different than a 25-year old who has their first job and maybe just got married. They have different goals, and you build the portfolio off of the return you’re trying to achieve. Now, of course, everybody wants as much return with as little risk as possible, but at the end of the day, it doesn’t really work that way. You have to craft a portfolio over time that’s going to fit the goal.

For example, what you were saying earlier, if you have somebody that is 25 and they don’t need bonds in their life, they’re making an active bet to own 100% stocks. Right there, they’re active, period. There is no passive. How they do it is you can do it a lot of different ways, but they’re making an active bet, so to me, is there even such a thing as passive? I don’t really think there is.

Casey Keller:                      I don’t think there is from a standpoint from that context. I do think there’s an active versus passive in the context of if you’re trying to get access to a particular area of the market. For example, if you wanted to buy healthcare stocks, you could go buy an index fund that owns all of them or you can buy a fund that owns maybe five or 10 of them where they’re trying to cherry-pick the best ones, so I think there is a little bit in that context, that debate, but in what you’re talking about, I think everything is an active bet.

Karl Eggerss:                      Right.

Casey Keller:                      Like you said, every decision in terms of building a portfolio, and we know folks, some people like real estate, so they choose to invest in rental properties or any … They’re actively involved in real estate, which may be good, but it may do better than the stock market, it may not, and so they’re actively making a bet that they’re going to either A, they’re going to outperform or they’re just more comfortable doing that, versus somebody that maybe just has all bonds, and they may not keep up with somebody that’s a stock investor, but if that’s what is more comfortable, they’re making an active bet based on their preferences.

Karl Eggerss:                      Yeah. Again, to me, it doesn’t really matter what you call it. If it does go back to the financial plan, and again, somebody needs 7% a year to live the life they want to live, then you go back historically and you say, “What type of portfolio over time could have achieved that?”, but you still have to look at the current environment, right? It’s hard to say, “Well, stocks make X over the last 50 years,” but they’ve made a much higher percentage in recent years, then your expectations got to be lower, so I think we have to … When you’re looking at your portfolio, whether it’s quarterly or annually or daily, you have to look and say, “What are my expected returns?”, so you look at historical.

We know stocks are the best-performing asset class generally over the last 100 years, but you still have to say, “What are my expectations going forward?”, and then back into a portfolio. I think if you want to be even more active, that’s where you do have to say, “Okay. Well, if I need 7% out of my stock portfolio,” and I don’t think the overall stock market’s going to do that, that’s when you have to dig down a little deeper and say, “Do I want to own healthcare specifically versus the overall market? Do I want to own value versus growth or small cap versus large cap, or international versus domestic?” Yes, you’re becoming even more active, I guess, but you’re still making some decisions to try to get a better return, but to me, it all goes back to the financial plan of, “What are you trying to do?”, I mean, because again, somebody that’s sitting there that’s 20 years old with a Roth IRA, bonds don’t play a part in that, but they’ve made a decision not to own bonds, so let’s just take the passive off the table and kind of steer the conversation towards, I would say being a little more selective and trying to figure out, “Do I just want to own the whole broad market or do I want to tweak it by trying to enhance it?”

Casey Keller:                      No. Absolutely. I think a good example of that would be fixed income, and if you look at just bonds, what was it … I will definitely 40 years ago, on the late ’70s, early ’80s, you could have … If your goal was to earn 10%, you could have just bought CDs and bonds and accomplished your goal.

You fast-forward to today, what CD rates or what, one and a half, 2% maybe if you’re lucky, to go, “If your goal is to get 5%, well, you know you have to do something different than just CD,” so that is a active decision to go, “What do I have to do?”

Karl Eggerss:                      Right. Right. Yeah, and the reason you make an active decision is because of what you’re trying to achieve, right? You don’t just blindly put a portfolio together, and I unfortunately, I think folks do watch TV, they read magazines, they get tips off the internet, and they build a portfolio based on that, and you kind of have to reverse engineer and kind of start with the end in mind first, and then make these tweaks to them, because we see them. We see portfolios all the time. Folks come in here, we look at their portfolio, and we say, “How did you put this together?”, and they say, “I don’t know.”

“I just, my uncle gave me this stock. I saw a bald-headed guy on TV, throwning stuffed animals at the screen, and he said that this stock was going to be great, so I bought some of that.” Yeah, you can’t do that. I think if you do well, the only way you probably do well over the long-term in that is if you get a big tailwind of a bull market that masks a lot of those errors that you probably are making.

Casey Keller:                      Right, and until it’s too late, I guess, but …

Karl Eggerss:                      Right.

Casey Keller:                      No. I think that’s a very good point that, that’s where planning comes into place, where you kind of look at a situation and go, “What do you need to earn to accomplish what you want to accomplish either in retirement or for saving for a college goal? How much do you need to save? What do you need to earn?” If that number is 5%, do you need a portfolio with a bunch of individual stocks that’s really aggressive?

Yet, maybe you could, but it may be taking undue risk and compromising the goals by, if the market goes the wrong direction. You may be taking on too much risk, so that’s where that planning comes in and trying to match the active bet you want to make if you will, to go back to that, yeah.

Karl Eggerss:                      Yeah. I think as opposed to calling it and labeling it active versus passive, or I’ve even have, I’ve heard people say, “Oh, I don’t like mutual funds,” or “I don’t like individual stocks,” I think you agree that we look at this as a big, old tool belt, right? It’s like going into Sears if you can find one, but what you used to do is go into Sears, and you’d go into the tool section and it’s like, “My gosh, look at all these tools,” that’s what the investing world’s like, and you go in there and you say, “I’m building something. I need this, this and this to build what I need to build.” That’s all this stuff is, are a bunch of tools, stocks, bonds, mutual funds, ETFs.

They all serve us purpose, so for us over the years, we’ve always used a lot of different tools because we’ve dealt with a lot of different people and a lot of different situations, so who cares if it’s active or passive? What’s the job we’re trying to do? Give me the right tool belt with the right tools in it, and we can get the job done.

Casey Keller:                      Yeah, so the tools you mentioned, Karl, each of those tools have their own unique characteristics.

Karl Eggerss:                      Right.

Casey Keller:                      Some tools, if you kind of look at every tool, we look at through the lens of either how much liquidity they have, how much safety they have, or how much growth they have, and because we know that no single tool has all three of those.

Karl Eggerss:                      Yeah.

Casey Keller:                      Meaning that-

Karl Eggerss:                      I wish they did, but I haven’t found one yet.

Casey Keller:                      Yeah, you know what? We’re still looking. You’re right. If we find [crosstalk 00:23:38]-

Karl Eggerss:                      Yeah. I mean, a rental house. You can’t just flip a switch and have that liquidated the next day. Whereas the stock, you can, but you probably aren’t going to wake up with a rental house worth 20% less, whereas a stock, you very well could, and you’re never going to make 15% in a year on a CD.

Casey Keller:                      Exactly.

Karl Eggerss:                      Maybe take out the 1970’s, but you’re probably not going to do that, but you have the safety aspect of it, so you’re right. The key is to blend those things together, so not only you have different tools, you have different characteristics of those tools, so let’s try to get away from active versus passive. It’s really, to me an irrelevant argument and it really doesn’t help anybody achieve their goals.

Casey Keller:                      Yes, I would agree with that.

Karl Eggerss:                      All right, everybody. Have a Merry Christmas, and we will see you next week back here on Creating Richer Lives, the podcast. Don’t forget, 210-526-0057 is our telephone number or Make sure you sign up for Covenant U. It’s our educational piece that goes out every Monday afternoon with all of the items we’ve put onto our website throughout the week, and nice, consolidated, one email per week.

All right, guys. Have a good weekend.

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