In Part I of this blog, I covered the importance of a fee-only pricing structure as one of the two most important components in how my wife Šárka and I chose to define success when founding Posey Capital Management. In this Part II, I’ll address the second component: applying a passive investing strategy.
Passive investing seems deceptively simple, and yet it is the most disciplined and sophisticated way I know of to expect to achieve your investment goals.
· Active investors -- Hope to beat the market by trying to make wily predictions about where stocks, sectors or the market as a whole is headed next. They try to buy future winners and sell future losers.
· Passive investors -- Assume that it is too hard to make these kinds of predictions in a generally efficient market. Besides, the increased costs of trying are highly likely to outweigh any benefits. Instead, the passive investor seeks to act on matters that are within his or her control: (1) fine-tuning the amount of market risk/reward in the portfolio to match personal investment goals, and (2) equally important, doing so as cost-effectively as possible.
To me, passive investing makes a whole lot of sense. But it doesn’t make for catchy headline news. The strategy doesn’t change much based on market whims, so maybe it’s not exciting enough to report on regularly. Like most people, I had to discover it on my own by looking past the popular press and big-name fund managers.
My personal path to passive came through a Morningstar analysis I was conducting in the early 1990s, while still an active investment advisor. I came across a Dimensional Fund Advisors (DFA) fund that looked good to me, so I placed a buy order. Or, more precisely, I tried to place an order. I was shocked to learn that, to purchase DFA funds, I first had to be on their approved advisor list, which required that I attend their two-day educational seminar. Oh and, by the way, I would have to pay my own travel expenses.
When we founded Posey Capital, my corporate goal was to establish a rigorous, intellectual approach to investing based on analytics rather than hunches. I wanted a strategy that would withstand the test of time and various market conditions. So, despite — or maybe because of — the unusual requirements, I wanted to know more about DFA’s “odd” approach. Šárka and I decided to attend the seminar.
It turned out to be one of the single most intellectually stimulating experiences in my life. I learned how DFA builds its fund solutions according to decades of academic inquiry into the science behind capital markets, asset allocation and passive investing. No wonder they first wanted me to understand what they were about.
I realized I had found a strategic alliance with a mutual fund company that would enable me to pursue my corporate goal. Next, I was faced with a decision. I was convinced that passive investing was the right way to go, and that I could use DFA funds and a few other resources to do it. But how was I going to communicate the strategy to clients? I didn’t guess most folks would be interested in a two-day seminar. My compromise solution was to devise a presentation (really, a conversation) I can typically do in about three hours, to educate clients on how passive investing works, and why I recommend it.
I chose this approach before I knew for sure if it would work as a business strategy. Would investors commit to this level of education? For me, it was a choice I felt I had to make, because I strongly believe that taking the time to help my clients understand how and why they’re investing is in their best interest. More than a decade later, it’s a choice I would make all over again, in exactly the same way.
