Passive investing: less effort for a better return

Keytrade Bank logo

Keytrade Bank

What if the best investment strategy is to just to do nothing? Let's explore the subject with passive investor and author Tim Nijsmans and Keytrade Bank Chief Strategist Geert Van Herck.

Most investors put together a portfolio themselves or opt for the convenience of investment funds. Why is this not a good idea?

"Active investors try to outperform all other investors together. These 'other investors’ are also known as 'the market'. Active investment is therefore about choosing your own investments in order to outsmart all those other investors," explains Tim Nijsmans. "And this costs money: transactions, taxes and management fees don't come cheap. With all these costs and opponents, it is very hard to achieve a higher return than the 'market' average. It is so hard, in fact, that most investors never manage to beat the market for several years in a row. Many try, but few succeed." "If you invest actively as a private individual, you lag behind from the start. Most stock market investors are professionals who have access to much more knowledge and resources than you do," he continues. "The crazy thing is that even they rarely succeed in beating the market time and time again. Trying to ride the same waves as these professionals (i.e. buying their investment funds) may seem like a smart idea at first. Their investment funds offer diversification and require no effort on your part. However, their returns likewise do not outperform the market. Roughly 95% of actively managed investment funds fail to consistently outperform their benchmark over a period of five to ten years." “The love of these investment funds has grown historically,” Geert Van Herck says. "Back in the 1980s and 1990s, every village had one or two banks. Of course, they always offered products that are most interesting in a commercial sense: funds issued by the bank itself, also known as in-house funds. We have only started to let go of this tradition in recent years, partly thanks to the rise of online brokers and the democratisation of investments in general." "All banks are saying the same thing: the customer is at the centre of everything they do. But if the customer is at the centre of everything they do, why do so many banks still only offer funds? Or worse still: in-house funds only?" states Geert Van Herck. "If the customer is truly at the centre of everything, all banks would also offer trackers. Unfortunately, many Belgians are not yet aware that this alternative exists and is easily accessible."

What exactly makes trackers more interesting?

"A tracker – also known as an ETF – tracks a basket of investments at a low cost. This generally does not require any active decision making by a fund manager, which means you don't have to pay for such services either. Avoiding these costs can make a significant difference when it comes to long-term returns," explains Geert Van Herck. "Trackers are generally also more transparent than actively managed funds. You know exactly what shares or bonds you are investing in because a specific index is being tracked. Because trackers are traded on the stock exchange, they also tend to be very liquid. This means you can easily buy or sell your positions whenever you want, which is not always the case with some investment funds."

“Trackers also offer advantages over selecting stocks yourself,” adds Tim Nijsmans. "You have to realise that very often only a minority of shares are responsible for stock market growth. According to a study by Hendrik Bessembinder, the overall stock market performance is only determined by 4% of all shares. If you don't invest in these shares, there is every chance that you will not perform as well as the stock market. And because of the stock market's unpredictability, you cannot say in advance what shares they will be."

"This brings us to the spiritual father of passive investing: John Bogle," states Tim Nijsmans. "He came up with a solution to the problem of stock picking that is both simple and efficient: don’t look for the needle in the haystack – just buy the haystack. Instead of hopelessly looking for that golden ticket, it is better to just buy the whole market, including the future winners. An added advantage is that you don't have to look for it again and again either. And you will automatically benefit when they start to rise. This is what trackers can do for you."

How does passive investing work?

“The essence of passive investing or passive management is that you no longer make choices or try to beat the market,” explains Tim. "You simply buy 'everything': you get a slice of each share, a small piece of each bond or a part of each building. This means you no longer have to pick what to invest in. No more futile studying of shares, no more meticulously trying to determine the perfect timing for a certain bond, and no more attempting to estimate what the return of an investment will be. This is useless anyway. It’s actually better to stay passive and let the entire market and investment world do the work for you. You can do this by investing in one or more trackers. Trackers simply follow the market at a very low cost. One crucial aspect of passive investing is that you actually stay passive. Trying to outsmart the market doesn't work, so why bother? All it can do is make you miss out on returns. In other words, as a passive investor you should take as few actions as possible and no action at all where possible."

A portfolio of just one, two or three trackers? That takes the fun out of investing, doesn't it?

"Virtually all investors are constantly tempted to do 'something'. In passive investing, you need to let go of that competitive element. I’m smarter than the market or I’m going to choose a share, theme or industry others haven't spotted ... You have to abandon that type of eagerness," asserts Tim. "I agree, it may not be quite as much fun, but you still have the tension of a market that is constantly in motion. By the way, actively investing in individual shares is still a very interesting activity. Unfortunately, it is also a very expensive one."

Is passive investing less stressful than active investing?

“This depends on how you approach it, because you can also invest very actively with passive instruments,” explains Geert Van Herck. "The aim of passive investing is that you don't pay too much attention to your investments. This is why trackers are a very suitable instrument for this. The advantage of a tracker is that the work happens automatically: falling shares disappear from the index and are replaced by rising shares. You don't 'see' these movements in a portfolio of trackers. In a portfolio of individual shares, you can see all those individual securities bouncing up and down a lot more, which is naturally more nerve-racking." “It has been proven that people who rarely look at their portfolio achieve better returns than people who keep looking at the graphs and ploughing through the reports morning, noon and night,” explains Geert. "If you invest and the stock market starts to fluctuate, you may be tempted to let your nerves and emotions dictate your actions. Those nerves and emotions are your biggest enemy on the stock market. Controlling them is very difficult, because as an investor you are constantly being spurred on: on social media, on news channels spouting analyses around the clock, etc. Every day, there is a never-ending stream of buy and sell recommendations. My advice would be to look at your investments as little as possible and to simply make sure you don't miss the boat when the stock market rises. And you can only do this by staying invested, because no one can predict the course the stock market will follow." "As investors, we also tend to experience choice overload and fear of missing out, or FOMO. This is unsurprising, given that we know we can choose from more than 58,000 shares and even more investment funds worldwide. This obviously results in choice overload for investors, leading to poorer choices and reduced satisfaction with their decisions. Investing in trackers eliminates this problem. You don’t look for the needle in the haystack – you just buy the entire haystack," explains Tim Nijsmans.

Is investing in thematic trackers also considered passive investing?

"I have my reservations in that regard. It's an exciting subject, and for some investors thematic trackers do deserve a place as portfolio satellites. But make no mistake: investing in thematic trackers is not a type of passive investing or passive management. This is active investing with a passive instrument. You choose products that are popular on the stock exchange. And what is popular is often expensive. Of course, what is expensive can become even more expensive or the balloon may deflate entirely," Tim Nijsmans warns. "People usually don't like it when I say that thematic trackers (and funds) in the water industry are very expensive. It’s a theme that has already delivered excellent returns. However, the underlying shares are extremely expensive because many people are investing in a limited number of companies involved in the theme."

Finally, what are your tips for beginner passive investors?

  • On average, the stock market rises seven years out of ten, so stay invested. Stay passive.
  • Don't buy dozens of trackers, as you may be buying the same companies. If you buy a tracker on the S&P500, Nasdaq and MSCI World, for example, you will have Apple in your portfolio three times already.
  • If you buy an MSCI World tracker, bear in mind that the shares you are buying are almost 70% US shares. Germany is barely represented at just 2%, even though it is the third largest economy in the world. You should therefore consider diversification by also investing in other regions – a tracker for Europe and/or emerging markets, for example.
  • It may be a well-worn cliché, but too many people plan to invest in the long term, yet still sell their investments after two years or less because they need the money. So think about your time horizon first.
  • Another cliché which is very important all the same, especially if you don't have an advisor: determine which risks you are willing and able to take. If the stock market fluctuations of recent weeks have scared you, it is better not to invest entirely in stock trackers.
  • Choose accumulation trackers. Reinvest the dividends immediately. You will still benefit from the dividends, even if you do not receive a cash payment. Reinvestment may also be more interesting from a tax perspective.

Just starting with passive investing?

Choose your trackers yourself or opt for a ready-to-use package of trackers.

This article does not contain any investment advice or recommendation, nor a financial analysis. Nothing in this article may be construed as information with a contractual value of any sort whatsoever. This article is intended for information only and does not constitute in any way a commercialization of financial products. Keytrade Bank cannot be held liable for any decision made based on the information contained in this article, nor for its use by third parties. Every investment entails risks such as a possible loss of capital. Before investing in financial instruments, please inform yourself properly and read carefully the document "Overview of the principal characteristics and risks of financial instruments" that you can find in the Document centre.

Other articles that might interest you