Originally published at: Understanding the Stark Difference Between Passive Investing and an Active Risk-Managed Strategy – Peak Prosperity
Last week, Paul Kiker took us through the retirement and financial planning process he uses with every prospective and existing client. That generated a lot of interest and led to several questions we’re going to address.
So today is about understanding the pros and cons of both passive investing and taking an active, risk-managed approach.
As with all complicated things, there’s no one right answer because investors come in all sizes, ages, and unique financial circumstances.
Passive investing essentially means staying invested according to a predetermined allocation, regardless of changing market conditions, valuations, or emerging risks.
For example, doing a monthly 401(k) contribution (perhaps with a company match) that goes into a 60/40 set of stock/bond funds. Is the market up? The money goes in. Is the market down? The money goes in. IS the market fairly priced? The money goes in. IS the market wildly overpriced? The money goes in.
Paul makes the case that passive strategies can make sense during the accumulation phase of life, when younger investors not only have decades to recover from market declines but benefit from buying at lower prices.
But a retiree (or someone close to retirement) can be absolutely devastated by a downturn coming at the wrong time for their life’s financial arc.
Alternatively, a risk-managed strategy continually assesses upside potential versus downside risk, establishing decision points at which investments are reduced or exited when the risk-reward relationship deteriorates, and which are increased when the risk-reward relationship is favorable.
The way Paul executes a risk-managed strategy removes emotions from the decisions and follows a plan with clear advantages and disadvantages that fit within a defined plan that has clear goals.
We also spent some time distinguishing volatility from risk. This is important because Wall Street and its marketing arms (CNBC et al.) have spent decades trying to get everybody to conflate the two.
So, here goes. Volatility describes the movement of asset prices in either direction, while risk exists in situations where the potential downside becomes disproportionately large relative to potential upside.
You know what’s made this all much harder to navigate? Constant government and Fed interventions. Those have inverted, if not perverted, the usual market signals that provide insights into actual market risk and reward.
But, as Paul says, you have to play by the rules as they are, not as we wish them to be.
Timestamps
00:00 The Risk of an Overvalued Market
00:38 Why Passive vs. Active Matters
02:57 What Passive Investing Really Means
05:13 When Passive Investing Buys Regardless
09:43 Why Time Changes Everything
13:49 How Passive Investing Can Hurt Retirees
16:00 What Risk Managed Investing Does
23:19 Volatility Is Not the Same as Risk
28:40 Measuring the Downside Risk
36:50 The Pros And Cons of Passive vs. Active
40:47 What History Says About Retirement Risk
42:44 Why Investors Are Getting Twitchy
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