Biggest Misconceptions Around Passive Investing | You Gotta Be Kidding Me!

Feb 23, 2016

By: Josh Fabian

tastytrade has a straightforward objective: educate investors on how they can manage their own money. Inherent in that objective is demonstrating the perils and misconceptions around passive investing. Therefore, we have to take on an establishment whose existence is predicated on individual investors remaining ignorant.

It’s a David versus Goliath battle and Tom has the hair to prove it.

Consider the following hypothetical: An investor with $100,000 is debating either investing in a no-load mutual fund that mirrors the Russell 2000 or sell one put option in RUT, which equals a notional value of $100,000.

Fund companies love singing the praises of no-load funds because they can make it sound as if all your money is being put to work. But ask yourself this simple question: would these firms be able to not only survive but thrive if all your money was actually being put to work just for you?

The truth is, no-load funds have management fees that amount to around 0.50% basis points or more per year. On a $100,000 investment, that means $500 is siphoned off before being put to work. That $500 could have been used to scalp in and out 167 times.

No-load funds need active management in order to maintain balance with the underlying they seek to replicate. Changes in capital flows and index fluctuations make it necessary to rebalance funds. As covered back in November 2015 during an episode of You've Gotta Be Kidding Me, an outright purchase of all 2000 Russell components would cost $480 per $100,000 in execution slippage. 

That is an additional 48 basis-points that no fund talks about on top of the 50 basis-points being lost to fees. That means before your money has even had a chance to start working for you, 1% has already been used up on various fees.

At tastytrade, we understand active management means taking on risk in exchange for opportunity and control. No one has ever achieved success without taking on risk. Or, as I like to say, there is nothing in life worth having that you don’t have to work hard to get and harder to keep. If you think simply handing over your money to someone is safe, you’re wrong. The current market should make that clear. Paying a fund to mirror an index down more than 11% should be insulting.

Taking on risk is where individual investors stand the best chance of being rewarded. At the end of the day, passive investors are money managers’ best friends. Passive investors simply cannot achieve the same rewards as active investors. Don’t believe me? Watch Tom explain it here.

If you have any questions or comments on passive investing, feel free to leave a comment below or reach out to us at support@tastytrade.com.

Josh Fabian has been trading futures and derivatives for more than 25 years.

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

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