Interesting read (about 5 minutes) from Of Dollars and Data that describes why passive investing is less likely to leave you with psychological scars that lead to sub-optimal decision-making:

Think of it this way: If you put a sizable portion of your net worth into individual stocks, and those stocks underperform the market, this would challenge your identity. You might start to think that you were a loser because you made a choice that lost you money. This explains why investors tend to sell their winners and hold their losers for far too long. They are hoping that the losing stocks will rebound so that they will be vindicated as good active investors.

This point particularly resonated with me because I have such a large percentage of my portfolio in index funds and yet what attracts my attention on a daily basis; I can’t stop myself from checking my stock positions that make up less than 1% of my portfolio:

I still remember having 2% of my net worth in a tech stock and checking it like mad throughout the day. EVERY. SINGLE. DAY. However, I never batted an eye when my passive investments (the other 98%) fluctuated on a daily basis and gained or lost far more money than that one tech stock. The passive investments didn’t define me in the same way as my 1 active stock pick. I wasn’t any more of a winner or loser when my ETFs changed in price, because investing in broad based indices like the S&P 500 didn’t feel like making a prediction.

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Want your students to experience more examples of the psychological stresses of investing, try these interactives:

• The Balloon Test
• Think You Can Beat the Market?

About the Author

Tim Ranzetta

Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.

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