What is active,semi-active, and passive investment?
The way that I define these are as follows:
Active - Fully participating on a day to day basis. Think law for a lawyer and plumbing for a plumber. This gets a little confusing as there are certain asset classes that have both active, semi-active, and passive investors. For example, real estate development. One can be the real estate developer and be active, and one can own a share of a Real Estate Investment Trust (REIT) and be completely passive. What determines whether it is active,semi-active, or passive is the involvement of the individual.
Semi-Active - Think of this as participating on a part-time basis. For example, investing in a company and being an advisor or board member is a form of semi-active. Owning real estate but having a property manager is a form of semi-active.
Passive - Doing little or no continual work in the investment. For example, the most passive investment is a public index fund.
I also classify an investment that requires initial due diligence but no ongoing maintenance as a passive investment.
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Outside of being clever, what is the point of segmenting different kinds of investments into these groups? Are these definitions arbitrary or can they serve some purpose?
The reason that these definitions are needed is because typically investments are only evaluated on their returns on money and not on time. This is unfortunate as typically the return on the latter is more important than the return on the former.
Let's take a look at some examples of how individuals make inferior investments across the return/time horizon:
When figuring out whether an investment is "good" one needs to consider the opportunity cost of both capital and time.
For example, let's say that you are a high priced lawyer that makes $500/hour. Now, let's say that you manage a real estate property that brings you 8% returns a year and is a $100k property. Does this make sense?
On first glance, an 8% return is a great return on real estate. HOWEVER, it may very well be, depending on how many hours it takes on a given year to manage the property that this investment is one that has a negative economic benefit. In other words, you could have just worked 30 extra hours in your profession and earned an extra 15% of the house value. (For simplicity let's discount tax effects).
The point then is to minimize your activeness while maximizing your returns. For example, the best case scenario is to capture an active return through passive means. Of course, this can be very difficult to do and requires a little luck. What is very probably, however, is capturing an active return with semi-activeness and a semi-active return with passiveness.
It is important to remember that EVERY investment (even a mutual fund) needs somebody that is highly active. The goal, when considering how to maximize financial gain, is to minimize your activeness by partnering with somebody that is maximally active. Another way to increase this is to make sure that you can maximize control so that you do not have to spend energy on going against the grain.
One "hidden" activeness is stress. Often times I see individuals hold an index portfolio that has a volatility that is higher than one's natural ability to tolerate stress. This stress can take away energy which could better be used for activity within own's profession that would farly exceed the returns in their passive portfolio.
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