At What Point Do Passive Investing (Boglehead) Principles Not Apply?

A reader writes in, asking:

“I’ve been a boglehead passive investor for several years now. I’ve fed myself a steady diet of writing by Benz, Bernstein, Roth, and Piper. My question though is whether boglehead-ism (if that’s a word) is really only a middle-wealth sort of thing. Does the same advice really apply to people at the more distant ends of the economic spectrum?”

At the lower end of the economic spectrum, there are some priorities that should be taken care of before investing at all. Namely, paying off high-interest debt and building up a bit of an emergency fund should both be done before we start putting any money into mutual funds, ETFs, etc. And it may be the case that there are education opportunities available that offer a better return (by increasing one’s income) than we’d expect to see from stocks and bonds.

But as soon as it makes sense to start investing, the core concepts of passive investing (diversify, keep costs low, buy-and-hold) are applicable. Something like an iShares Core Allocation ETF is a great choice for a new investor. It’s diversified. It’s low cost. It requires no ongoing maintenance, and as an all-in-one fund, it encourages healthy investing behavior (i.e., buying and then leaving it alone).

Admittedly, expense ratios aren’t super critical if we’re talking about a modest amount of money. For example, for a $1,000 portfolio, the difference between a 0.1% expense ratio and a 0.2% expense ratio is a difference in expenses of just $1 per year. But there’s still no downside to picking funds with low expense ratios.

The concept of diversification is, if anything, even more critical at modest levels of wealth. For instance, somebody who is late to the game with saving and investing really can’t afford to be risking large amounts on individual stocks.

And the same goes for taking a buy-and-hold approach rather than trying to move between stocks/bonds/cash at exactly the right times. If you don’t have any money that you can afford to blow up, it makes sense to just pick an asset allocation that’s suited to your risk tolerance, and then stick with it.

At the very wealthy end of the economic spectrum, passive investing may not be the only reasonable option, but it is always a good option. And it would still be my preferred option, for most people.

The larger the portfolio, the more critical it becomes to minimize costs. So as mutual funds go, it still makes sense to pursue super diversified, low-cost ones.

And predicting stock market crashes or interest rate changes doesn’t become any easier just because you have a large portfolio, so the buy-and-hold part of passive investing is still just as relevant as it is for anybody with a smaller portfolio.

One thing that does change is that the larger the portfolio, the more access you will have to various vehicles that invest in private equity or private debt. And at a higher level of wealth, there’s a greater ability to put assets at risk in such vehicles, without risking financial catastrophe.

But just because you can invest in something doesn’t necessarily mean it’s a good idea. The expenses for such private market investments tend to be quite a bit higher than for simple ETFs or index funds. And such private market investments tend to be dramatically less diversified. That means that they have the ability to provide truly mind-blowing performance. They also have the ability to provide quite lousy performance, which is then made even worse by their high costs.

Regardless of performance, relative to boring ETFs, private market investments tend to be more complicated, less transparent, less liquid, and harder to incorporate into tax planning, cash flow planning, or estate planning. In many cases, if the portfolio is already quite large, that means we don’t need returns greater than what we could expect from boring ETFs. And if you don’t need the hoped-for high returns, why bother with the hassle?

To my mind, the passive/Boglehead style of investing is just as prudent, regardless of whether we’re talking about the low range of the wealth spectrum, the high range, or anywhere in between.