The return in focus

For many years, even proven financial experts have not agreed on whether the active or passive investment strategy is the means of choice if a high return is desired in the long term. Well-known investors and experienced fund managers often swear by an active investment and thus seem to have enormous successes. Private investors feel insecure when they cannot constantly follow the development of the markets and therefore completely refrain from buying stocks or funds. You could achieve considerable returns with a passive investment. So how does the active and passive investment strategy differ? And which variant is better suited to the action of the private retail investor?

Active investing is for professionals

The term already suggests what an active investment strategy should be. The investor observes the market, he decides every day again in which stocks, funds and other securities he wants to invest. Its stated goal is usually to generate a high return within a short period of time. Usually he is more interested in a short to medium-term investment period. Those who regularly keep an eye on the markets, who correctly forecast developments and invest in promising stocks or other securities, often have very good experiences with an active investment strategy. Well-known investors like Warren Buffett earn millions in profits by buying and selling a few stocks in a short period of time. You seem to have the right instinct when it comes to choosing stocks that are promising and that will see significant gains in value over a short period of time. And even very experienced fund managers reap extremely pleasing returns with an active investment. Of course, investors who invest in such a fund also benefit from this. So is active investing the key to happiness when building personal wealth?

Passive investments bring solid returns

While an active investment strategy is usually about achieving better returns than the market, a passive strategy focuses on continuous growth in value over a long period of time. So you don't want to be better than the market in the short term, you want to grow with the markets in the long term. Passive investing is therefore much more relaxed, because it eliminates the often short-term buying and selling of securities on the stock exchanges. Therefore it is not necessary to keep a constant eye on what is happening in the market. For example, if you take out a fund savings plan and invest in a particular fund month after month, you can sit back and relax as the value of your shares increases over the long term. A passive investment can also consist of buying an index fund, the development of which replicates the performance of a stock index. For example, if you invest in an index fund from the German stock index DAX, the long-term performance of the fund should roughly match the performance of the DAX. However, there is no need to change anything in an investment that has already started. Since this is a passive strategy, you buy a set amount of shares every month and benefit from the long-term growth of the markets.

Experts see a clear winner

Although finance professionals have not agreed for many years which of the two investment strategies will bring the better returns, recent studies show a clear trend. For private investors in particular, a passive investment brings higher returns in the long term. On the one hand, this is due to the fact that the active buying and selling of securities leads to higher transaction costs. On the other hand, the reason is that high returns always require an enormous knowledge of the market in order to buy and sell at the right time. Unfortunately, only very few fund managers have knowledge of the interrelationships between the markets and their potential development. That is why reputable investment advisors usually recommend the passive investment strategy for private investors.

passive asset accumulation with stocks

Many investors who invest in the stock market would prefer to always put their money on the biggest winners. Frequent reallocations are the result. But "back and forth empties pockets" is an old stock market adage. Anyone who reallocates their securities account through sales and new investments must, on the one hand, pay fees for the transactions. The higher the number of transactions, the higher the costs. On the other hand, there is no certainty that the new papers will bring more profit than the old ones. In fact, an American study suggests that if you invest for several years, the average return for investors is higher than if you buy and sell your paper frequently.

Researchers Brad Barber and Terrance Odean divided thousands of traders into five ranks. The distinguishing feature was how often they turned over their holdings. Those who traded the least (far left) kept most of their profits, but the impatient and hyperactive traders made their brokers rich, but not themselves. (The columns on the far right show a market index fund for comparison) Source: Prof Brad Barber, University of California at Davis, and Prof. Terrance Odean, University of California at Berkeley.

The US research shows that the right market timing is difficult in the capital markets. For a long-term asset accumulation with stocks, the right entry point is not at all decisive: Studies show that investors were able to more than make up for even larger price losses - for example after stock market crashes or financial crises - over time. For example, Bundesbank data shows how an investment of 10,000 euros in the German leading index DAX has developed if the saver invested shortly before the biggest equity crash in the recent past - i.e. at the worst possible time. The result: Those who invested the money shortly before the so-called “dot-com bubble” in 2000 were able to post an annual increase of at least 2.8 percent around 18 years later. Anyone who invested in 2007 shortly before the financial crisis achieved an annual return of 4.4 percent until 2018.

Why do the stock markets rise over the long term? The economy is growing steadily and with it the corporate values are also increasing. This is reflected in the stock market. A look back shows that stocks, despite temporary setbacks, generate the greatest profit over long periods of time. So staying power is more important than timing when building wealth.

The investor is therefore well advised to let his money work for you as long as possible. If you want to avoid the high risk of a direct investment in stocks and want to avoid the optimal entry and exit point, you can invest via an ETF (exchange-traded fund).

Why are ETFs so well suited for long-term investing in stocks?

There are many reasons to put Exchange Traded Funds (ETFs) at the center of your investment strategy. Especially when you compare their strengths with the investment alternatives. ETFs combine the advantages of a stock that can easily be bought and sold on the stock exchange with the advantages of a traditional mutual fund that distributes the assets. The aim of an ETF is to replicate the return of an index such as the DAX as precisely as possible. So you always know what you are investing in.

The market for ETFs has grown rapidly in recent years: In Europe alone, over 600 billion euros are now managed in ETFs (as of July 2017). Globally, the 4 trillion euro mark was exceeded at the end of June 2017. Where does this growth come from?

There are good reasons why these innovative funds gain fixed assets from active fund managers and have established themselves as a good alternative to buying individual stocks.

How is an ETF created?

Exchange traded funds are securities that move like an index and track it. Compared to other products, they have a very low tracking error, that is, a slight deviation from the desired index. ETFs, like stocks, can be traded daily on the stock exchange. They are therefore different from mutual funds that are traded by an investment company.

ETFs are passively managed products in which the fund manager does not do any stock picking. Often computers adjust to the index automatically in order to save costs. The creation of an ETF can be done in different ways. One form is the physical representation. Here, a company is founded that physically buys the shares that should be in the ETF. So the value of society fluctuates just like the values that are in society. In order to make this “movement” accessible to investors, the company is issuing its own ETF shares.

What kind of ETFs are there?

There are ETFs for funds, indices, industries, commodities, countries and regions. Special forms are short and leverage ETFs. A short ETF moves in exactly the opposite direction to the underlying index or basket of securities. A short EFT on the DAX makes 1% profit if the Dax falls by one percent. However, if the DAX rises, the investor also loses.

A leverage ETF, or leveraged ETF, participates disproportionately in the gains and losses of the underlying index. For example, an ETF with a leverage of 2 makes 4% profit if the Dax makes 2%. The downside is that the ETF also loses twice as quickly if the Dax slips into the red.

What are the advantages of ETFs

The main advantage of the ETF is its diversification, i.e. the division of the money into different industries, countries or securities. This minimizes the investment risk.
In addition, there is no issuer risk with physically mapped ETFs. For example, if you buy a certificate on the DAX that was issued by Commerzbank, you will not have a loss even if Commerzbank goes bankrupt, but only if the DAX falls.

These benefits also apply to mutual funds. As already mentioned, the advantage of ETFs is that they are often significantly cheaper than conventional investment funds. This is because they are passively managed and no active fund management has to be paid for.

The fund manager only tracks the index and only acts when it changes.

Broadly speaking: Simply invest in entire markets

Inexpensive: Low ongoing fees

Flexible and liquid: can be traded on the stock exchange at any time

Safe: ETFs are special funds

Transparent: investment strategy known at all times

How do I use the leverage effect when building up wealth with stocks?

In the case of stocks, wealth accumulation looks much better. In the stock market you don't have fixed returns, but many different ones.

Depending on the strategy and willingness to take risks, you can generate high returns. However, negative returns are also possible.

Let's take the DAX as an example. Since December 31, 1987, the DAX has gained an average of 8.34% (return on equity). If we calculate with this average value and 10,000 euros, then we have doubled our assets.

On the 10,000 euros invested capital, there is compound interest after 10 years of assets of 22,278.62 euros. So we made a profit of 12,278.62 euros.

That doesn't sound bad, especially because it's very passive. However, 10 years is a long time and you need a lot of equity to make large fortunes.

You can certainly leverage stocks, but most of the industry classifies this as extremely risky due to the volatility of stocks. Hence, it is also very difficult to find lenders for it.

Read: Stocks on Credit - blog article on der-kapitalist.net

The 2% inflation must also be taken into account with the assets. The nominal value will certainly remain the same, but you will be able to buy less of the money in the future.

Investing Like Baron Rothschild and Warren Buffett: The Methods Used by the Most Successful Investors of All Time

"BUY WHEN BLOOD IS IN THE STREETS"

Baron Rothschild is said to have once said: “You have to buy when there is blood in the streets”. Perhaps I would not express it quite as drastically, but he had recognized that changes in currents and trends are often indicated by armed conflicts.

The accompanying economic recession will make goods such as food very expensive, but capital such as machines or production facilities will tend to be cheap to acquire (due to political uncertainty, lack of demand and lack of money). They are the same reasons that are given today when stock prices are falling. Star investor Warren Buffet has also used the same knowledge for himself, only in a slightly different way he said: "Be fearful when the world is greedy and be greedy when the world is fearful."

But what does such wisdom have to do with our times?

And even more important: What influence does this have on your own investments?

Fortunately, today the conflict is usually only fought out in the order book (listing of buy and sell orders for a specific security).

Rothschild said that wars and ruptures in current developments are a good indication of a turning point in the trend ... and what the world wars used to be is now the case of a bank (Lehman Brothers) or a fund.