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Investing

Should You Actively Trade or Passively Index Your Retirement Portfolio?

Calvin Lo

The longer I’m invested and the more I learn about investing, I’m increasingly convinced that I should not be actively trading my retirement portfolio. I suspect the same might be applicable to most investors as well. In my opinion, most retail investors should be well-served by adopting passive investing strategies at least for the bulk of retirement funds.

I’m not saying that there’s no place for active trading in pursuit of higher returns vs benchmark indices. If you’re a full-time investor or trader, or work with investments professionally, you might have an edge over the average part-time retail investor. Otherwise, you either must have a solid trading/investing strategy and/or are willing to spend countless hours researching stocks or charts.

Why Are You Investing?

In reality though, most of us are part-time investors and probably unwilling ones as well. If I wasn’t investing for my retirement, I probably wouldn’t even be in the stock market right now. When I first started earning an income, I played stocks for a bit and lost lots of money. It was only when I got married and started a family that I seriously got back into the stock market. Sometimes I like to take a step back and remind myself why I’m invested in stocks in the first place.

I measure my performance regularly vs S&P 500 and so far, I’ve been underperforming by a mile. So I often question myself, what’s the point of actively trading our retirement portfolio? Isn’t it easier to just buy the index instead? Why do investors still bother to invest in individual stocks or actively trade in and out of stocks?

Knowing your why can help you decide whether to pursue an active trading strategy or a passive indexing one.

Why Do We Trade Actively?

Maybe to some, the S&P 500 index’s long-term average annualised total returns of 9% in nominal terms or 6.8% in real terms (adjusted to inflation) just doesn’t cut it. If you’re gunning for higher long term returns, then you might have to resort to more active strategies but be acutely aware of the higher risk you’re taking (which may not ultimately pay off).

See report from McKinsey – Markets will be markets: An analysis of long-term returns from the S&P 500

Source: McKinsey

Or maybe we have (an often misplaced) confidence in our ability to trade stocks/options profitably or to find the next big stock. Many might have been fooled into thinking this during the pandemic fuelled euphoric rally (including myself, I admit). As one of my favourite saying goes, a rising tide lifts all boats but when the tides goes out, you find out who’s been swimming naked.

S&P Indices Versus Active (SPIVA)

While looking into this, I came across this study from S&P Dow Jones Indices called the SPIVA US Scorecard that tracks the underperformance of active fund managers vs their category benchmarks. Take it with a grain of salt, since the research done by S&P which is after all an index creator.

This might not be representative, but I take active fund managers as a proxy for active retail traders (since data for performance of the latter seems notoriously difficult to find).

See table and charts below for the data gathered:

Source: SPGlobal (data as of June 30, 2022)

Here are a few things we can observe or learn from the data:

  • Active strategies perform better during downturns
  • Active strategies fare worse over longer periods of time
  • Even active strategies couldn’t escape the implosion in growth stocks

Final Thoughts

Keep in mind that famous investors, e.g. Warren Buffett, Peter Lynch, Stanley Druckenmiller, are probably the outliers. They are some of the smartest investors who have spent many years focused on investing and probably have an army of analysts doing the grunt work for them.

As part-time investors, do we really think we have the ability to outperform these guys given our other priorities in life and our 9-5 job? If you have been outperforming the market, congrats to you but I’ve certainly come to realise it might not be worth the time and risk to try to do so especially over many many years until retirement.

For our retirement funds, we might be better served by steady and somewhat predictable returns albeit lower than we desire (isn’t it always?).

Over the past year or so, I’ve been purposefully transitioning more and more of our portfolio funds into passive index funds. In addition, I’m automating the investing process where possible. Since I’ve been underperforming the market, I’ll be happy if I can just earn market average returns in the coming years through index funds. I’d rather channel my focus to increasing my income, reducing my expenses and most of all, spending more time with family.

That said, I’m not totally giving up active trading or individual stocks but I’ll be reducing the portion of our retirement portfolio dedicated to active strategies or alternative investments. Eventually, I might consider fully transitioning our retirement portfolio (Family Portfolio) to passive index funds and reserve the active strategies exclusively to my Personal Portfolio.

Do you actively trade your retirement portfolio and if so, how has your portfolio been performing?

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Disclaimer: This is not financial advice. I am not professional financial advisor nor do I work in the finance industry. Anything I write here is purely my personal opinion. Please do your own research and due diligence before investing into anything. All investments come with associated risks. Best to consult a financial advisor if you’re still unsure.

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One thought on “Should You Actively Trade or Passively Index Your Retirement Portfolio?”

  1. Agree totally, with index investing one is more likely to be on the right path….long term.
    For me, just 25% of my investments are in active-buy/sell trading.

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