To begin, let's define Passive and Active Investing, using the S&P500 as our stock index.
Active investing is the managing of a portfolio to perform better than the S&P500. This is achieved by investing in high growth stocks while avoiding declining stocks.
Examples of active investing include trading individual stocks, day trading, options, hiring a portfolio manager, or buying an actively managed fund, as the manager of that fund is doing some combination of the above.
Passive investing is the managing of a portfolio to match the performance of the S&P500. This is done by buying a fund that is tracked to the index, meaning it mimics the performance of the S&P500.
An example of this would be buying shares of an an S&P-tracked index fund like this one.
I suggest different ways to invest based on one's goals and risk profile, but I have unequivocally denounced active investing. So why am I so adamant about not even trying to do better than average?
The biggest reason to not even try is because you will underperform the index. How do I know this?
Think about every transaction you make when you trade stock. In order to sell, there has to be someone on the other side buying, and vice versa. When you take the sum total of every transaction, you end up with the index. The index is the sum total of all its trades. The price of the index increases when shares are bought, decreases when shares are sold.
But this leads to the conclusion that active trading will on average, result in you doing just as well as you would passive investing. So what is it about active investing that makes it not worth the effort?
1. Financial Cost
Active investing incurs MUCH more fees than passive investing. We are talking about a difference of one magnitude or more. The US tax laws are also highly unfavorable towards active investors.
2. Time Cost
Active investing is a full time job. People take years to learn the ins and outs of trading. And on average, they perform at the level of the index. Even if you have unquestionable reason to believe you will outperform the index/ average active trader, how much would you have to outperform them by in order to justify the time spent doing so?
3. Dunning-Kruger Effect. It is human to believe you have evidence that you will perform better than average. If you think this, you are not only mistaken, you are likely to be below average.
There is much more conclusive evidence that show the futility of active management if I did not convince you here. And I can understand if you still think it's worth your time, after all I showed no data or math to support my assertions, so to reject my argument would be perfectly reasonable.
In the absence of hard evidence, I leave you with a clever analogy: Searing meat versus cooking low and slow. Contrary to conventional wisdom, searing meat dries it out, and meat cooked low and slow retains far more moisture. Now it's true you won't get the delicious color if you use a slow cooker, but that's assuming you're good enough not to burn the meat searing it. In the markets, we don't have that kind of information. In fact, we have all sorts of cognitive biases and external noise working against us. So a better analogy would be if you were cooking blindfolded- Now which would you choose, the hot pan or the slow cooker?