Investing makes for one fantastic spectator sport. Just think about it; watching the wild gyrations of the market without committing capital on an outcome can certainly reduce the number of sleepless nights.

But actual investing, when done properly, is a much better participatory sport.

Yes, there’s nothing quite like taking some capital, moving it into, say, your new favorite stock, and feeling overjoyed as it rallies…

But many investors are lazy, and employ a strategy you may have heard of: it’s called passive investing.

In reality, there’s no real way to invest while being passive about it. Anything that’s worth doing is worth doing well, even if it means a lot of time and effort is required.

Let’s say that using the passive approach in stocks led you to purchase, back in 2003, some shares of Proctor and Gamble. Your passive approach was to buy and hold—and passively manage risk with a 20% trailing stop.

Seems like the best of both worlds—the potential for upside, and a stop that rises with the stock to ensure that, after the price goes up at least 20%, you’ll lock in some gains.

This approach would have worked pretty well on a venerable consumer-staple play like P&G, whose low Beta of .53 meant that it should have only moved half as much as the markets. But then the 2008 wipeout happened.

Passive Investing Seems Like a Winner for P&G…

On September 12th, 2008, the share price was $73.15… less than 2 months later, on October 27th, the share price was at $57.27… about a 22% dip that would have gotten our theoretical investment stopped out at $58.86.

And our passive investor? Taken out, and probably grateful considering the state of the market.

No big deal, though, right? After all, it’s a big, blue-chip company and the lower price made a better entry point, provided our passive investor was paying enough attention to get back in.

In the case of small cap stocks, which are the nursery for the next generation of mega-cap stocks, a periodic 20% correction is pretty commonplace, only to bounce to new highs that reward more patient investors.

Could you have taken this passive approach while investing in small caps like Berkshire Hathaway in the 1960’s or Wal-Mart in the 1970’s and still hold million-dollar positions in those equities today? Nope, you would have been wiped out ages ago, a victim of your own passive investment style. Heck, you might have even sold at a loss!

So, what, then, is the best investment style? One that recognizes risk on an individual basis.

A blue-chip, company with a solid history of dividend growth, like Proctor & Gamble, is the sort of position where a stop-loss strategy, depending on your time frame, might not be appropriate…especially if your entry point is near a bottom (don’t delude yourself into thinking you can time exact market tops or bottoms).

One of the biggest mistakes investors make is getting suckered into the delusion that investing can be profitable when it is passive and scarcely time-consuming. In reality, it’s nearly the opposite, and such laziness only leaves capital underutilized.

Frankly, if you don’t have the time to make these kinds of investment decisions, then the services of a money manager would be more appropriate for you.

Of course, if you do that, you’ll have to diversify among money managers, and keep an eye on what they’re all doing…

Bottom line: investing is like any other sport—watch it all you want, play a few games with friends, but if you want the kind of market-crushing returns that make legends, you’ve got to take the time to become a pro.

Stay Sovereign,
Andrew Packer, Managing Editor of The Sovereign Individual