Chapter two of The Elements of Investing covers index investing. When it comes to investing, nobody knows more than the market. William F. Sharpe put is simply in an article many years ago when he wrote – The Arithmetic of Active Management. I find it humorous that Sharpe did not use the word mathematics in the title. Instead, he used arithmetic which implies something simpler than mathematics. Click on the link and follow Sharpe’s logic. It really is quite simple.
Another favorite book that supports the thesis of index investing is Richard A. Ferri’s volume, “The Power of Passive Investing.” Ferri’s book goes into much more detail of the benefits of index investing than does The Elements of Investing.
While we use index securities such as VTI, VOE, VBR, TLT, etc., not all the portfolios adhere strictly to admonitions of Malkiel, Ellis, Sharpe, Ferri and many other writers. The ITA portfolios that most closely follow the words or advice from these authors are the Schrodinger and Bohr. And the Bohr has only been operating passively for the last few months.
The Dual Momentum portfolios come next in line to passive management as all use index securities and all follow a mechanical approach to investing. Judgment is, for the most part, removed from managing Dual Momentum portfolios. While there is some action or active management, it is minimal, particularly for those DM portfolios using the one-year look-back period. The passive management purest would not classify or place Dual Momentum portfolios in the passive bucket. For example, anytime one places a TSLO under a security, it is a “violation” of the passive model for investing. I suppose we could classify DM portfolios as partial-passive accounts.
The Dirac portfolio falls into the actively managed portfolio bucket as individual stocks are selected. Stock selection is considered active management.
Where do the Tranche Momentum or Relative Strength portfolios reside? While all use index ETFs as the choice for portfolio inclusion, the HA, BHS, and LRPC models are all elements of active management. When one is making decisions such as toggling the VTI target filter on or off, one is making an active management decision.
Malkiel and Ellis argue for index investing and push it one step further to passive management. However, somewhere in the book they do mention that they use active management for part of their portfolios. When Ellis was on the Yale investment board, he certainly participated in active management.
If in doubt, I recommend passive management for most investors. The very simple and straight forward approach would be to purchase an index fund such as VTI, VFINX or VTSMX and do nothing else. Just save and index invest. Those wishing for more downside protection will gravitate toward the Dual Momentum model or use one of the models built into the Kipling spreadsheet.
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