On the fifth day, an Oracle from Omaha descended from thee heavens. “Today,” he said, “I bring you thy S&P 500.”

So it began.

From all across the lands, people began pouring their earned coin into this magical transcendent creature.

“Here ye, here ye! Take all your monies! We can deposit it monthly or quarterly or weekly. We shall call this act, passive investing!”

And that my friends, is the start of passive investing. The story of how it all came to be…

Act 1

Did you know the S&P 500 Index is actually owned and operated by a company. That company is the S&P Dow Jones Indices. Did you also know this company has over 10,000 employees. Some of those employees, well actually a lot of them, work daily to manage all of the indexes they sell, market, and create.

They add stocks, they remove stocks, they debate new and old methods, and they probably get into some nasty board room fights here and there about what stocks should go where. They have entire committees dedicated to these processes.

I can read it to you if you want, straight from them:

“All committee members are full-time professional members of S&P Dow Jones Indices’ staff. The committee meets monthly. At each meeting, the Index Committee reviews pending corporate actions that may affect index constituents, statistics comparing the composition of the indices to the market, companies that are being considered as candidates for addition to an index, and any significant market events. In addition, the Index Committee may revise index policy covering rules for selecting companies, treatment of dividends, share counts or other matters.”

I’m not sure I see the “passiveness” of a monthly meeting to decide what stocks should go into a basket of equities. I guess what I’m saying is that the indexes people passively invest in, are, quite frankly, actively managed. But perhaps there’s more to this story. Let’s keep going.

Act 2

The other day I was being shown some interesting new software for passive investors. Here’s what I was told:

“You ready!? Our website is going to make life easier for passive investors. Before you do automatic deposits into different asset classes, you need to take a risk assessment test. Depending on your risk level, the website automatically tells you what assets are good for you. It’s that easy!”

I’ve found myself pressing buttons and moving sliders on this website. I want to take massive risk. Nah, I want to take no risk. The website spits out new assets and allocations just for me depending on where I moved these sliders and how I press certain buttons. I can invest in an aggressive basket of assets or a conservative basket of assets.

But wait one second. What exactly are these assets I’m being recommended?

It turns out, most of the “assets” these machines recommend are really just ETFs. I could end up in the TLT ETF, sometimes known as the biggest Longterm Treasury Bond ETF. Or I could find myself in the popular Nasdaq-100 ETF called QQQ.

Lucky me.

It’s at this point, in my journey to understand passive investing, that I think I’ve cracked the code. Passive investing is just buying ETFs on a set schedule whether it’s each paycheck or each quarter. The machine has told me I need exposure to classic US Treasuries. So I find myself searching the official TLT ETF website for more information. I think I’m ready to jump in!

Act 3

“Well that’s weird.”

I’ve just learned the Treasury Bond ETF, the one I was looking at called TLT, is managed by two people. As of this writing, this ETF has $17 billion in assets under management and yes two people are responsible for steering the ship. Not my words, their words:

“Portfolio Managers James Mauro and Scott Radell are primarily responsible for the day-to-day management of the Fund. Each Portfolio Manager is responsible for various functions related to portfolio management, including, but not limited to, investing cash inflows, coordinating with members of his portfolio management team to focus on certain asset classes, implementing investment strategy, researching and reviewing investment strategy and overseeing members of his portfolio management team that have more limited responsibilities.”

There’s nothing wrong with this. It’s kind of nice to meet our portfolio managers James and Scott. I wonder if they like avocados… But what you’re also telling me is that by taking the machines recommendation to diversify into a low cost ETF managed by a couple of guys walking around an office yelling about inverted yield curves is passive investing. Okay then.

Act 4

The name “passive investing” is good.

It’s friendly. It’s easy.

What’s really happening, however, is a little marketing department has done something clever – that somehow this passive investing thing is better, different, and safer. But in reality, passive investing is the same thing people have done in financial markets since the dawn of the Buttonwood Tree: we trade our hard-earned money to buy a paper asset like a stock because we estimate it will create bigger future returns than if we just held our cash money and did nothing with it.

There’s no secret sauce here.

The funds you buy can screw up just like anyone else can. So yes, you might be a passive investor, but you surely aren’t investing in anything even close to what the word passive actually implies.

What I’m saying is someone behind the scenes of all those ETFs or whatever fund you think qualifies as passive investing is actively moving money and assets around. When I say actively, by the way, I mean like sometimes daily. ETFs rebalance and move things around all. the. time.

Curtain Begins to Close, @Scheplick Walks Unto the Stage

Passive investing was built by those who need your money to continue conducting the alchemy of finance. You see, if it’s too easy, the people will just do it themselves. If it’s too scary, no one will ever want to do it. You need the perfect mixture of too scary and not easy enough and voila – money deposited, business earned.

Just as fast as passive investing became a wonderful buzz word in a massive bull market, it can also become a shunned marketing phrase in a devastating bear market. Because at the end of the day, that’s all it is… a marketing word.

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