The Passive Investor Test

Passive investing is all the rage. Active has become a four-letter word.

Are you a passive investor? Let’s find out…

1) Do you own a higher percentage of stocks in your portfolio than bonds?

2) Does your house make up the largest component of your net worth?

3) Do you ever rebalance or sell/change the holdings in your portfolio?

4) Do you dollar-cost average, reinvest interest/dividends, or engage in tax loss harvesting?

5) Do you own any individual stocks/bonds/real estate?

6) Do you own only bonds issued and stocks domiciled in your home country?

7) Do you invest in lifecycle or target date funds that change the mix of stocks/bonds over time?

8) Do you own anything other than cap-weighted index products?

9) Do you hold a large amount of cash for emergencies, for when the market “finally” pulls back, or to “sleep at night?”

10) Do you exclude private equity, preferred stock, MLPs, commodities, collectibles, and other more esoteric asset classes from your portfolio?

If you answered YES to any one of these questions, you have failed the test. You are not a passive investor. Do not be dismayed. Everyone will have answered yes to at least one of these questions which is why, in practice, there are no truly passive investors. There are only varying degrees of active.

Let’s go through each of the above questions to make this point clearer.

1) 60/40: An Active Bet

A 60/40 portfolio of U.S. stock and bond index funds is often referenced as the passive standard. In reality, though, it’s far from passive because it’s not close to the “market portfolio.”

Public equities accounted for only 36% of investable assets at the end of 2012 (see Doeswijk, Lam, and Seinkels). Of this, U.S. equities represented roughly half.  So instead of holding 60% in U.S. equities, a passive exposure would be closer to 18%.


Source: “The Global Multi-Asset Market Portfolio,” Financial Analysts Journal (2014)

On the bond side, the active bet most U.S. investors are making is even greater. According to Vanguard, non-U.S. bonds are the world’s largest asset class while most U.S. investors have very little international bond exposure.


Source: Global fixed income: Considerations for U.S. investors, Vanguard (2014)

2) Your Home is Your Castle … and an Active Bet

If you’re like most Americans, the vast majority of your net worth is tied up in your house. The median 65-69 year old American has $194,226 in net worth but only $43,921 if you exclude home equity.


Source: Motley Fool via U.S. Census Bureau

Leaving the question of whether a house is a good investment aside, putting most your money into your primary residence is an extremely active, concentrated bet. The truly passive investor would never buy a home. They would instead be a renter and invest all savings into the global market portfolio.

3) Rebalancing is Not a Passive Activity

Rebalancing a portfolio back to “target” asset allocation weights is said to help investors control risk and maintain their desired risk-profile over time. There are a number of rebalancing strategies in existence. They are all active.

Why? Because a true passive investor would buy the market portfolio and let the weights float over time to wherever the market goes. If that meant owning a much higher percentage of equities and tech stocks in 2000 because of the dot-com bubble, then you’d have to live with that.

Rebalancing in 2000 (selling stocks and adding to bonds) may have been a prudent decision to control risk, but it was very much an active bet.

4) The Lump Sum Fallacy

In its purest form, passive requires a lump sum investment into the market portfolio on the day you are born and only sold on the day you die.

But that’s not how investing works for anyone. For in between, life happens. And a life worth living is not a passive event.

Most don’t start investing until their twenties and when they do it’s not a lump sum but dollar-cost averaging small amounts into a 401k or IRA. The amounts are not static over time but hopefully growing as you advance in your career. Those dollar-cost average returns can look very different from buy-and-hold returns and since you’re not dollar-cost averaging into the true market portfolio, you are by definition making an active bet.

Even if you did buy the “market” on the day you were born the question of reinvestment of dividends and interest payments comes into play. Do you reinvest, which greatly enhances long-term returns, or do you take the money and spend it? If you spend it, that’s an active decision. If you reinvest but not into the true market portfolio, that’s also an active decision.

Do you engage in tax loss harvesting to offset taxable gains and potentially reduce ordinary income up to $3,000 per year? That sounds like an active decision to me.

5) The Stock Pickers Dream

Indexing is becoming more and more popular but the temptation to pick individual stocks is still strong. Anyone who dreams of being the next Warren Buffett won’t get there by buying an index fund. If you own any individual stocks, bonds, or real estate investments you are deviating from the market portfolio and making an active bet.

This is true regardless of whether you ever sell that stock or not. Buying and holding Apple is an active bet.

6) Jack Bogle is Home Biased and So Are You

The father of indexing and founder of Vanguard, Jack Bogle, does not diversify abroad, holding only a portfolio of U.S. stocks and bonds (he also believes in 60/40 and rebalancing, which as we established above are both active bets). His rationale: “I like the U.S. We still have plenty of problems, but we’re much better than France, Britain, and Germany. And we don’t even want to talk about Italy and Greece. And importantly – people forget this too quickly – we have the most established government and legal institutions.”

Bogle is not alone. Equity market home country bias is pervasive in not only the U.S. but globally.


Source: The global case for strategic asset allocation and an examination of home bias, Vanguard (2017)

7) Targeting a Date is an Active Decision

Target Date or Lifecycle funds have become increasingly popular in recent years. Just pick a retirement date (2035, 2040, etc.) and the funds will automatically shift the mix of stocks/bonds to a more conservative allocation over time. This automation is said to make the shift passive, but it is nothing of the sort. The starting and ending allocations are hardly representative of the global market portfolio, and managing risk as you approach retirement, while often prudent, is an active decision.

8) Value Investors = Active Investors

Just because you turn something into an index doesn’t mean it is passive. If you are deviating from the market portfolio by owning only what you deem to be “cheap” stocks, even if done in a systematic (rules-based) fashion, you are making an active bet. The same is true for any “smart beta” product, momentum strategy, trend following strategy, etc. If you don’t own the entire market you are actively avoiding what you don’t own.

9) Cash is the Active King

Cash may be king but it does not mesh with passive investing. If you are holding a large cash balance for emergencies, because you are waiting to buy a house, or because you are waiting for better investing opportunities, you are making an active decision. It may be a wise decision, but it is still active.

10) The “Market” is Not Just Stocks/Bonds

Thus far we’ve been largely focused on “investable” asset classes. Richard Roll (Roll’s critique) argued back in 1977 that the true market portfolio is “unobservable” as it would need to include every “single possible available asset, including real estate, precious metals, stamp collections, jewelry, and anything with any worth.” This would include your own business if you are self-employed, one of the most concentrated active bets one can make.

Needless to say, it is impossible to gain exposure to such a portfolio. As such, it is impossible to be a true passive investor.


Moving On, Elevating the Discourse

Once we can acknowledge that there is no such thing as a true passive investor we can move on to a more intellectual conversation than the juvenile “active is bad, passive is swell” discussion that has dominated in recent years.

A more interesting debate to me would include the following questions:

1) Should one ever deviate from the investable market portfolio (as anyone with a 60/40 allocation is already doing)? If yes, when/why?

2) Is the significant concentration of wealth that Americans have in their primary residence a good thing for the economy? Is such an active bet warranted? Do other developed nations have the same concentration?

3) Is rebalancing a form of market timing with a more palatable name?

4) Did the exponential increase in ETF assets in recent years, even passive index ETFs, encourage more/less activity from investors? Do investors in ETFs reinvest dividends/interest at the same rate as mutual fund investors?

5) Starting your own company is one of the most active decisions you can make. Most startups fail (“half of the businesses started in the U.S. live five years or less“). Does portfolio theory suggest one should not make such a bet and instead assume a more passive role within an established multi-national company?

6) Has Jack Bogle’s decision to invest only in the U.S. hurt him or helped him from a risk and return standpoint? Should that matter for your own portfolio going forward?

7) Are lifecycle funds and robo advisors really an effective replacement for an investment advisor? How closely do they track the true market portfolio?

8) Are stocks/bonds good enough? How much additional benefit do investors get by including more esoteric asset classes? Should commodities be a part of the market portfolio?

9) How many ETFs would it take to replicate the investable global market portfolio? What single fund/ETF most closely approximates this portfolio currently?

10) Does strategy diversification (managed futures, value, momentum, merger arbitrage, etc.), while a deviation from the market portfolio, provide any benefit to investors over time?


I’ll be tackling these questions in upcoming posts.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.



Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.


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