Active vs. Passive Investor

Are you an active or a passive investor? There are fundamental differences between them. One can generate outsized investment returns but put in more work, and the other often generates lower returns and has little ability to control this outcome. If you want to see which one you are and what it takes to change from one to the other, or better yet, utilize the best elements of both approaches, read on.

The Exclusive Passive Investor

A passive investor is primarily limited to stock market investments that they may or may not manage independently. Most passive investors choose a combination of mutual funds and ETFs to invest in that are tied to specific sectors of the economy or target a particular set of companies, such as technology firms. Most will hire a financial advisor to help them choose an appropriate portfolio and spend the rest of their time on their job and other activities.

The passive investor has no input on managing these funds, what they buy or sell, and when. The only real control they have is choosing when to buy or sell an investment. If they decide to invest with index funds, they will ride the market up and down through volatility, growth, and crashes. There is nothing they can do to influence these cycles, but they can panic, sell at the bottom, and then come in and buy at the top, guaranteeing a dismal return over time.

Depending on how their portfolio is constructed, they will generally earn about the market average return, possibly a little better or worse, depending on which specific investments they have chosen. They will get monthly or quarterly statements, which most won’t read, and maybe meet with their financial advisor yearly. Sadly, this describes most investors. Most employees who join a company-sponsored 401(k) plan won’t do this much and will have even worse investments to choose from than the average investor.

The Active Investor

The active investor has levels of sophistication based on their expertise and time to be involved with their investments. In all groups, they will be a hands-on type of investor but may still achieve wildly different results based on their approach. Here are the various levels of active investors.

The Active Stock Investor

This investor will stick to the stock market but often choose most of their investments or take a much more hands-on approach if they use a financial advisor. They generally take the time to read financial news, study markets and possibly take additional education on trading systems. These investors will carefully review statements, calculate rates of return, and tinker with their portfolios. This investor may purchase funds, ETFs, individual stocks, or bonds. The main feature of this investor is that they will stick to stock market investments and diversify their portfolio by choosing various funds or companies to give them more or less exposure to various sectors, but always within the bounds of the stock market.

The Advanced Active Stock Investor

This investor will also stick to the stock market but rarely use an advisor and will pride themselves on the advanced research they do for each investment. They are far more likely to trade individual stocks and bonds. Still, they may move into advanced financial instruments such as options, derivatives, commodities, and currencies and employ various advanced trading strategies. This investor will maintain subscriptions to newsletters, trading news, and platforms that your less advanced investor will not. This investor will often trade daily and perhaps even do some day trading. This investor may also have access to primary offerings of new companies and may be an accredited investor. Finally, this investor may consider themselves a professional trader, even if that isn’t their daily occupation. As with the active stock trader, their investments will still be within the stock, bond, or commodities markets. These investments can be actively managed with brokerage accounts through companies like TD Ameritrade or Charles Schaub.

The Exclusive Active Alternative Investor

This investor will swear off most Wall Street investments except possibly private equity purchases or early-stage startups that are years away from going public. Some of these investors will not purchase any stock or bond. They will stick to investments such as real estate (direct ownership) and private limited partnerships in gas, oil, alternative energy, private equity, cryptocurrency, or other alternative investments. This investor will often find and assemble their deals directly. These investments will usually involve finding the deal, drafting contracts, doing due diligence, bringing in experts to evaluate various components, and directly owning and possibly managing whatever they invest in. This investor can be an accredited investor, but not always. Accessing some investments, such as syndicates or certain energy partnerships, will require accreditation.

This investor may not be accredited but choose to stay entirely away from Wall Street. I know many real estate-based investors that have never purchased a single share of stock in their life and never will. Instead, they choose to find investments they understand and have a lot of control over.

These investors rarely have any Wall Street trading accounts with big-name companies like TD Ameritrade or Robin Hood. If asked, many will say that they don’t trust or understand the investments from Wall Street and instead enjoy finding, structuring, and managing actively and directly owned assets. I will discuss some case studies later. This investor would be most closely aligned to the Advanced Active Stock Investor but in alternative investments.

The Advanced Combined Investor

This advanced investor moves back and forth between Wall Street and Alternative investments. They understand both types of investments and see the use and need for each type. They may or may not be accredited but will directly own alternative investments and have a stock portfolio that they actively manage. This investor will combine aspects of all the various groups of active investors already outlined above. They will likely be more involved in Wall Street or Alternative investments based on their expertise and interests. It is unlikely that this is their only profession.

This investor is very comfortable finding, assembling, and managing various alternative investments while simultaneously choosing Wall Street-based investments. They may use advanced strategies in either group of assets and is very comfortable moving capital around to find the highest and best use for that capital between alternative and Wall Street portfolios. This investor has strategic reasons for holding investments in more traditional and alternative investments.

Professional Investor

This final category is an investor with no other profession besides managing investments. This investor is undoubtedly accredited and will access every type of investment available but works with enormous amounts of money. This investor is likely assembling multi-million-dollar deals and maybe juggling more than one at a time. This investor typically works in private partnerships that manage millions of dollars in real estate, private placements, hedge funds, and syndicates.

This would be an investor that owns large commercial real estate, large residential multi-family real estate, golf courses, private equity, syndication, and early-stage venture capital. This type of investor will often work as a hedge fund owner, venture capitalist, or private investor with millions of dollars in money to work with at any given time. Think of individuals like Mark Cuban, Warren Buffet, and other large but more private investors. This group is likely to be only 1% of all investors in the world. These investors have connections and resources that dwarf any ordinary investor. I won’t spend much time discussing this group because I know little about them. I am not in that class, and most people reading my blog won’t be either. If you are in this group and you are reading my blog, call me 🙂

Which Investor Class Are You

Now that you have read the above descriptions, take a moment and classify where you fall in the spectrum. No matter where you are today, you can move to another group; if you are a passive investor with almost no knowledge of what or why you are in one investment or another, you need to get educated and move to another category.

If you are an active investor but stick exclusively to Wall Street or Alternative Investments, you too can change and broaden your investment portfolio. It is simply a choice that involves education and the willingness to dedicate the time necessary to expand your investment horizons. Perhaps you are happy with where you are today and do not wish to change. If you are a passive investor with no desire to change, you will likely never achieve significant investment returns, but that may not be your goal. It is possible to be a passive investor who can retire comfortably without many money worries in the future, but you may not be so lucky. Unfortunately you will need a long investment horizon, high contributions, avoid stupid mistakes like selling after a crash, and a bit of luck and timing. I prefer to be a more hands on type of investor.

The Best Investor Group

This is a bit of a trick question. I will start by saying if you aren’t a passive investor, you are already doing much better than the average investor. Let me be clear here, don’t be a passive investor. This group will never achieve the returns or wealth they are capable of if they are willing to put in even a little work and education. This group is often taken advantage of by Wall Street. They are sold poor-performing funds that charge exorbitant fees that never beat the market average but very likely under perform it. Some might argue that a passive investor can invest in low-cost index funds and match the market returns. This is true, but they will never do better than the average, and when the market crashes, they go with it. If one of those crashes comes within five or even ten years of your desired retirement date, you might be in real trouble. You might not have enough time to recover before drawing down the funds. You are certainly more likely to run out of money at a very inopportune time.

Now that we have ruled out the passive investor as a goal to strive for, where should you be? In my opinion, you have the most flexibility and earning potential if you aspired to become an advanced combined investor. This investor group is comfortable in both Wall Street and Alternative Investments. It is certainly harder to be in this group because the amount of investor knowledge you require is broader and deeper, but it gives you the most flexibility.

As the Money Outlaw, I operate in this space. I have friends that are alternative investors and disagree with my choice. They wouldn’t touch a Wall Street investment if you gave it to them. I have other friends that are the exact opposite. They are comfortable with Wall Street choices and have no desire to venture into alternative investments. They feel they don’t have the expertise and don’t want to learn.

Why Invest in Wall Street

If you are only an alternative investor, you might ask the question, why would you ever need to invest in Wall Street? The stock market has made some people incredibly wealthy. Generally, these investors would fall into what I termed the “professional investor,” but there is still a lot of money to be made in the market by less heeled investors. Here are some of the key reasons why I choose to do it.

Liquidity

Stock market investments are incredibility liquid. You can buy and sell assets in fractions of a second and turn an investment into cash almost immediately. Conversely, you can turn cash into a performing investment very quickly. The speed at which one can buy and sell is a double-edged sword. It is easy to dump assets quickly during market downturns when you should be keeping them, and it is too easy to snap up investments that you shouldn’t touch.

Divisibility

It is simple to sell only a small number of stocks or bonds to raise the capital you need. You don’t need to liquidate an entire position. You can sell a little of a few different holdings, some of one, or all of one. You might be able to utilize what is called tax law harvesting if you follow the rules. This gives you both a tax loss and can raise capital you might need for something else. Unfortunately, with real estate it is harder to do this.

Diversification

The stock market allows you to access different sectors of the economy quickly. While I love real estate, it is not an indestructible sector. If you were a real estate investor during 2008 – 2011, you went through a brutal downturn. During this downturn, there were profitable sectors of the economy that you could access with stock market investments. In 2001 the technology sector crashed and took several years to turn around, but other sectors did fine. Wall Street investments allow you to quickly move into or out of assets that are the highest and best use of capital. As I write this growth stocks, which were the darling of Wall Street for nearly 10 years are getting their teeth kicked in, but there is some opportunity in value stocks or beat up growth stocks that will eventually recover.

Easier To Find Investments

I will have fellow real estate investors vehemently disagree with me on this one, but I think it can sometimes be easier to find good-performing investments faster in the stock market. I can hear the howls for my head right now 🙂 However, in my experience, this is still true; with so many businesses that trade publicly and the vast amount of investment choices in the market, I can almost always find a way to put capital to work. With alternative investments, I must find, assemble, and manage deals. This isn’t always easy to do. Finding a good real estate deal can be challenging, especially in the current market. Once I find one, I am often committed to that deal for a more extended time to see it through. With stock investments, I can almost always find something quickly and even short-term if necessary. Many Wall Street investors have a “buy list” of companies or assets they track and can quickly deploy capital. Yes, I am aware that doing so is far from a guarantee, and short-term capital gain taxes can be a real burden, but I still think, all things considered, this is a valid point.

Access to Professionals

This will also be a bit controversial, but the stock market has no shortage of people who consider themselves experts in it. Most are not, but it is still possible to locate talented money managers that can assist you in Wall Street investments. In my opinion, finding experts willing to help you with alternative investments isn’t quite as easy. I use an RIA (Registered Independent Advisor) to help me manage *some* of my market holdings. An RIA is a fiduciary and will not have a broker-dealer relationship. They are a wealth manager and will charge a fee for their services. Their advice is often solid because their fee is based on the returns. While there are financial friends in alternative investments, they are much rarer and not quite as easy to access. I still manage a lot of the Wall Street portion of my portfolio, but sometimes it is nice to be able to farm some of this out to an RIA and keep a close watch on what they are doing.

,The Downside to Wall Street Investments

As with all the pros I outlined above, there are some strong negatives to investing in Wall Street-based securities; you should also understand those. The reasons I outline below are what many of my fellow alternative investors would cite for their reasons for swearing off Wall Street forever.

No Control

The most significant problem with Wall Street investments is the complete lack of control over your assets. The market is entirely beyond your control. Economic forces that are far more powerful than any investor is at work. The market or individual stocks can easily crash and take you and your investments with it. You might not be privy to inside information on a specific company that could cause that company to drop 99% overnight and never return. You can’t get involved in running the company, choose the managers, or do anything that will affect the outcome of the investment. With many (not all) alternative investments, you can have a direct ability to turn the investment around or at least have a lot of influence on it.

Economic Forces & Bubbles

Related to the no control, economic forces and bubbles created by the Fed can wipe out the market and your investments and leave you and your money in a severe down position for a long time. If you need to sell assets for cash for any reason, you will sell at a loss. You can’t predict when these bubbles will pop or even if we are in the middle of one. Unfortunately, bubbles have been much more common since 2000, and I count at least three bubbles during the last 22 years. That is a problem.

No Leverage

With some alternative investments, real estate, you can often get involved with a low amount of money using creative finance and use borrowed capital to buy the asset. This is not possible with traditional Wall Street investments, and you will need ALL the cash upfront to invest. I can use a relatively small down payment in many (not all) alternative investments and leverage the rest. By the way, using margin accounts and leverage in assets like commodities is not what I mean by being able to use borrowed capital. Stock or commodities market leverage can be dangerous and unpredictable.

Case Studies

It will be instructive to see a few case studies of active investors and which investments they pursue. You can see which one appeals to your temperament and style. Understand that no two active investors will be the same; even if they follow the same approach, the investments they choose, knowledge and experience, and resources available will all be different.

Strict Alternative Investor – John

I have known John for a couple of years, and we have had lengthy investment discussions. John doesn’t like or trust Wall Street; he wouldn’t invest a nickel there if you gave him the nickel. He is a passionate real estate and note investor. He has multiple self-directed IRAs and a Solo K plan for his small business. John lives in California, where real estate prices are very high. He chooses to invest in mobile homes. His strategy is to buy a mobile home at a discount, often in need of repairs, and rehab it. Once it is rehabbed, he will sell it and carry back a note. He will keep, sell, or trade the notes depending on his needs.

He will do several investments in his self-directed retirement plans and works with a group of other investors to fund or partner on their deals. Sometimes he does this with his funds, and sometimes, his IRA will partner with him. If he needs to raise capital or go to cash, he will go to his network to borrow money or sell off a note. John is proficient at structuring deals and moving around assets to keep his money always working and moving from cash, paper, and property in an array of transactions that continually builds his wealth. We have discussed stock investing, and he has zero interest and likely never will.

Strict Stock Investor – Conner

I met Connor several years ago. He owns a well-known franchise, and while he has done some real estate investing, he doesn’t own any properties and says he has no interest in ever doing it again. His investments are strictly Wall Street investments; he manages his own accounts and doesn’t use an advisor. He enjoys the process of researching various companies and choosing his investments. He subscribes to several newsletters and investment advisory services that he uses to help him choose his investments. He avidly follows market news and adjusts his portfolio based on economic and company data he learns. He has dabbled with advanced investments like options but doesn’t spend much time pursuing those specific investments. Most of his investments are inside his retirement account.

Advanced Combined Investor – Money Outlaw

I am an avid alternative investor in real estate and notes and have dabbled in cryptocurrency and limited partnerships in the energy sector. My real estate investing is rather broad and includes rental properties, flips, options, raw land, and interest in short-term rentals. I would say that alternative investing is where my passion is and where I spend most of my investment time outside my entrepreneurial endeavors. However, I am also an avid stock investor.

I hold retirement plans with just Wall Street investments in them, and I have self-directed plans with just alternative investments. I do some investing in my retirement plans and some outside. With my traditional investing, I primarily stick to equities and some advanced strategies with options. As the value of my stocks increases, I will sometimes sell them and re-invest the gains in a new stock or pull it out and buy real estate. I have pulled some equity out of properties that I felt were not working hard enough and put it into stocks, but this is extremely rare. If I pull equity out, I often put it back into real estate elsewhere.

I prefer to use my stock investing as an engine to generate capital for real estate investments. As an alternative investor, I am like John moving around my alternative investments by buying, selling, and trading my assets to constantly improve my position, portfolio or generate additional cash flow. The ability to move between traditional and alternative investments gives me a lot of flexibility. If I suddenly come across a good deal or have a significant expense, it is easier for me to sell off some stock to get cash than to sell off a property or note. John would say the opposite. I will say the market fluctuations on Wall Street have caught me flat-footed more than once. As I write this, the stock market is in a bear market, and I am in a losing position on almost every stock I own. Yes, I could still sell them and raise cash, but I would take a loss for doing it. I am allergic to losses unless I am doing some tax loss harvesting, which I have done this year.

The other element I find helpful is having both traditional and alternative investments; I find it easier to keep my capital deployed and working because I can pick from almost any investment available. I know many real estate investors are always hunting for new deals and sometimes find they can’t locate a deal or end up with some cash and can’t find an investment to put it to work. If this happens, I can put it to work in alternative or traditional investments. If I can’t find real estate or notes to purchase, I can find a conventional investment to park the money and usually earn something on it while I am hunting.

I also have a lot of control over other elements, such as taxes. I usually build up a position over time in stocks, so if I need to liquidate, I can often use my early purchases and benefit from long-term capital gains. I can also do this in real estate. I have a lot of control over alternative and traditional investments that I find beneficial.

Conclusion

The main point you need to take from this article is that you should NEVER be a passive investor. Always be an active investor. It is OK to have passive investments, but there is a huge difference between an active investor that has passive investments and a passive investor. Don’t just turn your money over to a financial advisor and hope they will invest in quality investments that will beat the market. They won’t. Nobody cares about your economic well-being as much as you do.

If you are an active investor, I hope you choose to diversify beyond Wall Street. There are many reasons I don’t believe Wall Street investing will ever make 99.9% of the people wealthy. I think a solid approach is using both traditional and alternative investing. I believe each has its strengths and weakness; by doing both, you can mitigate and benefit from each.

I have made far more in alternative assets than in Wall Street investments, and I have had a lot of control over my real estate investing and the returns I can generate there. I have also made many friends and had the ability to do business with many incredible people that I wouldn’t have otherwise met if I had just stuck with Wall Street. Some of these people have become great friends.

Wall Street investing had allowed me to put capital to work long before I could find and execute good real estate deals. I can buy and sell stocks from my desktop during the day when I am working on other stuff. I have a variety of alerts set up that tells me when a stock has reached a price where I want to buy or sell it. However, several times, I have also found myself entirely underwater on investments through massive economic and market forces. It is depressing to log into your trading account at the end of the day and see you lost thousands of dollars in one day. That never happens with my real estate investments.

In the end analysis, I can see a day where I would swear off Wall Street completely, but for now, I like the flexibility of having both choices. Everyone will need to make choices about where they are most comfortable. I hope you will decide to join me in the world of alternative active investing at some point and see all the advantages that exist here. Happy investing!