Are Passive Investments for You?
“What is your take on passive investing?
If passive investing, what percentage of your portfolio would you allocate for “speculative investments”, like single tech stocks and such?” ~ Jake at I Heart Budgets asks this two part investing question.
Passive Investing and Speculative Investments
You don’t usually see these two topics discussed together. Passive investing is the cornerstone of John Bogle’s index fund investing platform. Backed by empirical research and millions of practitioners, one topic that’s rarely discussed with passive investing is speculation.
Well, here goes….
Passive Investing-My Take
Jake asks about my take on passive investing.
Where to begin?
I’ve dug deep into the empirical research stock return studies and embraced the passive investing approach. It is almost impossible to beat the market indexes year over year. In fact, the research is abundantly clear. Fund managers who beat the markets for several years in a row do not end up in the overachieving category indefinitely. They eventually drift to market performance or below.
Mark Hulbert, respected creator of the Hulbert Financial Digest reported in a legacy Wall Street Journal article “Can Market Timers Best the Index?” that during the last two market cycles, the 20 best market timers reduced portfolio volatility by 25 percent. But, had these same investors just bought and held a portfolio invested 80% in stocks and 20% in bonds, they would have earned a higher return with equivalent risk as the market timers. I wrote more about passive portfolio management versus active trading in “Is Buy and Hold Finished?”.
Why not save yourself time and go with the research and use a passive approach. Take a quick risk quiz and figure out your risk tolerance. Then invest percentages in the basic asset classes according to your risk tolerance.
Even if you love researching investments and looking for an arbitrage opportunity (chance to beat the market), consider your chances of long term success. Very low. One reason for the decline in success of active traders; today, investors aren’t competing against other traders. They are competing against complicated computer programs, who have no emotions with which to contend. The machines are going to win over the individual traders.
So here’s an alternative if you want to try your luck with speculative investments or an active trading strategy, put a small part of your investments in speculative assets like bitcoin or individual stocks.
Jake wants to know just how much to allocate to the “active” portion of his portfolio.
Speculative Investments-What Percent?
What percent to invest in speculative assets depends upon the size of your portfolio, your age, and your risk tolerance.
I’ve invested in many individual stocks and speculative investments and have experienced the high of a stratospheric gain. I bought Oracle in the 1990’s for a price in the teens and watched it top out above $100. I sold most of my position for a heady profit (I just wish I’d sold it all). On the other hand, I bought Nokia for $31 and sold it at $4. That wasn’t fun!
For those of you who think, “Invest in dividend paying stocks and you can’t lose”, read why that isn’t always a perfect strategy. I invested in a limited partnership for a private plane rental company and received a 12% dividend payment. The investment was required by law to pay out all earnings in dividends. Sounds great doesn’t it? It was wonderful, until the price of the limited partnership ultimately dropped 75%. I didn’t actually lose money on that investment since, over time, I recouped more than my original investment in dividends. But that investment demonstrates what can happen when you reach for the dividend sky.
At present, I invest in peer to peer lending through both Prosper and Lending Club. I have a small percent of our total net worth invested in this risky asset class. But with interest rates rising, and defaults mounting, I’m transitioning away from peer-to-peer lending. Additionally we still hold a few individual stock. The remainder of our holdings are in a portfolio of diversified index funds in line with our risk tolerance and a few managed funds in our retirement accounts.
What Percent Of Your Total Investment Portfolio Should Be Invested In Speculative Assets?
What is your risk tolerance?
First question, ask yourself how you will feel if you lose 100 percent of your speculative investment(s). That is possible with speculative investments. Use your response to that question to guide your speculative asset investment decision.
If you don’t mind risk and can still sleep if your portfolio makes a double digit fall, then consider a maximum of 10 percent in speculative assets or individual stocks. It also helps if you are younger (age 40 or less). If you’re younger, you have many years of earnings to make up your losses.
For most individuals, I wouldn’t suggest investing more than 5 percent of your net worth in risky assets. If you have a growing portfolio and you lose all of your money in your speculative investment, a 5 percent loss shouldn’t ruin you. And if you can’t afford to lose most or all of the speculative investment, then go back to a more conservative asset allocation.
Zvi Bodie, author of Risk Less and Prosper and the widely adopted academic finance book, Investments, authored with Kane and Marcus, is risk averse. He has almost his entire portfolio invested in inflation protected bonds and treasury inflation protected securities.
Final Take-How Much to Invest In Speculative Investments
As in most of investing, there is no one right answer. Clearly evaluate your personal situation to decide whether to invest in any speculative assets. Educate yourself so you know about the risks you are facing. Before I invested in the peer to peer lending platform, I read the Securities and Exchange Commission (SEC) documents. I focused on the risk section. There are great risks in this type of investing!
Be aware of the psychological pull to go with the crowd. Someone is always touting the new market timing system or forex or make it rich with options. Think and evaluate before you invest any of your hard earned money. And evaluate from whom you are getting your investment advice.
Readers, how much if any of your portfolio do you invest in speculative assets?
A version of the article was previously published.
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