The second investment philosophy believes just the opposite.  It believes that Timing and Selection is a fool’s errand; that the markets are efficient, diversification is essential to long-term success, and asset allocation is reason why your portfolio gets what it gets.  Believers include me, my money manager, (Matson Money), Dimensional Fund Advisors (DFA), ETF purchasers, indexers, Nobel Prize winning economists, and world-renowned academics.  We call this method of investing Passive Management and it is founded upon the principles of Academics and Economics.  (I’ll go a step further and say that Passive Management in and of itself is not a recipe for success.  You will need a trust advisor who will coach the RIGHT BEHAVIOR by employing the Passive Management at all times.  This is where the value of the advisor is, but I digress.)

Neither investment philosophy is right or wrong.  It’s what you believe works FOR YOU.  But I do think you need to enter this game knowing the rules and with your eyes wide open.  So know this: there is not one shred of evidence to support Active Management as a successful long-term investing strategy–NONE whatsoever.  (In fact, all the evidence support the use of Passive Investing). There is no academic paper, research, dissertation, or theory that proves that someone can know IN ADVANCE which investment will be the winning one. There is only anecdotal “evidence”.

I think inherently we all know this.  If someone were to pitch this method of investing to me, my cynical self would be asking, “If you know what the winning Mega Jumbo Millions Super Duper Lotto numbers are going to be, why are you telling me?” Unfortunately, the snake oil salesmen aren’t so forward as to say, “I know what the future winners will be”.  They use ambiguous terms and language to confuse.  They use hind-sight and past winners to point to the winning ones.  But at the end of the day, if the investment strategy relies on a prediction, then it’s a losing one.

Now please don’t misunderstand me.  Every year about 15-20% of money managers DO beat the market.  Statistics say that SOMEONE will beat the market–and handily.  Just as there will be someone in a crowd of 1,000 coin flippers who will flip ten heads in a row, there will be some manager among the thousands out there who will beat the market ten years in a row.  But just like the lucky coin flipper, you can’t identify who that will be in advance and you certainly can’t use his track record to bet that he’ll flip ten heads in a row the next go-around.

So please…if you believe in Active Management, then by all means, use a financial advisor who will employ its methodology by trying to time the market or pick stocks for you.  If, however, you believe in (and want to explore further) the Passive Management investment philosophy, you NEED to work with an advisor who will invest your money using sound economic principles and coach you to exercise the right behavioral skills.

Wishing You Every Success In The World,

John Choi

Active management says that there are smart individuals out there that can tell you in advance how much a particular stock is worth.  In fact the Wall Street marketing machine spends millions of dollars per year to convince you that they have this information.  I can’t help but to think that if this is true, why millions or better yet, billions, of dollars have been lost by the very firms who propagate this nonsense (Lehman Bros, Merrill Lynch, etc.).

Passive management says that the market cannot be beaten and it is impossible to predict who the future winners will be.  Make no mistake, there are those who beat the market in any given time period, but you cannot pick these lucky winners beforehand.  Who knew in advance that Peter Lynch would produce the returns he did.  Heck if Fidelity knew in advance wouldn’t they have closed all their other mutual funds and put all their investors into the Magellan fund?

Just getting started…

Comments welcome.

John Choi