My approach to investing begins in simple observations about what capital markets are and how they work. What are they? They are nothing other than vast pricing mechanisms for stocks and bonds. And how do they work? They bring together thousands upon thousands of highly motivated buyers and sellers who are continually resetting market prices for each and every security.
If you stop and think about just this much, you might begin to wonder about the omnipresent "Wall Street" view of good investing. Does it really make sense to be on the lookout for overpriced and underpriced securities, regularly buying and selling stocks and bonds to try to own the right ones at the right time? Or rather does it make sense to think that there is no better measure of a security's value than its ever-changing market price?
This is a conceptual beginning of a case for passive management over and against active management. This debate has a long history. I come down fully on the side of passive management. Most if not all of the arguments of active managers boil down to this: "The market is mispricing these securities and it will soon price them correctly as only I – truly insightful active manager unlike all the other active managers who are trying to do the same thing – can see!" People who take the passive approach are more humble, highly skeptical about being able to identify mispriced securities and certain about being unable to predict the future.
Someone might wonder: if good investing isn't what active management takes it to be, what's left? What does passive management look like? The basic strategy of passive management is to own the market as a whole so as to gain market returns. This is my beginning point in constructing portfolios for my clients. Accepting the market for what it is, letting it work for you rather than fighting it, this in itself can be liberating and transformative for investors.