By Patrick Manning, Head of Strategic Investments:

Recently my grandson who is 21 and my nephew who is 22 have expressed an interest in the stock market. Of course I encouraged both of them to pursue this interest, but suggested they first start by doing it in a play money account, rather actually investing. They are both in college and have very little to invest anyway.

Of course since I am a believer in Passive Investing, I gave them my spiel about how hard is to beat the market on a consistent basis and that when they get real jobs that it is very important to start young and put the core of their portfolio in index funds in their 401 K’s so they can have a comfortable retirement. I knew that this advice would most likely fall on deaf ears, as despite the fact that I was in the business for over 30 years, it took me until I was about 50 to figure this out.

Appealing to their competitive nature and the invincibility of youth I issued them a challenge. Put half of your paper portfolio in whatever stocks you want to pick and put the other half in the Vanguard Total Stock Market Index ETF (VTI) . No matter how many times you trade the stocks you pick or go in and out of the market, just remain fully invested in the half of your portfolio that is in VTI. Then we can see if your are in the small minority of people who can actually beat the market. They both took the challenge.

Because they were completely unfamiliar with the standard approaches to investing like fundamental analysis,technical analysis, P/E ratios, value investing, momentum approach, top down analysis, industry or sector analysis,etc., etc.; they essentially picked companies that they were familiar with or read about somewhere on the Internet. In many ways, my feeling is that this approach to stock picking is as good as any other. I say this because history and many academic studies have shown that wall street professional money managers that pick stocks and time markets do not outperform market averages about 65% of the time.

My nephew who has had his paper portfolio for about a year is being trounced by the market. My grandson who has only been at it for a week is losing money on 4 of his 5 stock picks, but one of them is a penny stock called Chromadex (CDXC) and it is up about 11.7% for the week. Thanks to that stock, he is actually slightly ahead of the market. Somehow I think that when his first year is up that won’t be the case. But kudos to my grandson, perhaps he will become the next Warren Buffett or Peter Lynch.

In my continuing quest for more knowledge on Passive Investing I look for good books on this topic. One I just finished that I think is worth reading is called ” Index Funds – The 12- Step Recovery Program for Active Investors ” It is written by Mark T. Hebner. This is the condensed 2011 edition. His first edition was praised by many well known financial industry and academic legends such as Harry Markowitz, John Bogle, Burton Makiel, and Paul Samuelson. It is an easy read and is chock full of common sense supported by many academic studies with market data that goes back as far as 83 years.

My other favorite books on the case for passive investing include: ” A Random Walk Down Wall Street” by Burton Makiel, “Common Sense on Mutual Funds” by John Bogle, and ” The Power of Passive Investing ” by Richard A. Ferri. If you want to get a little more involved in the math side and asset allocation then read ” The Intelligent Asset Allocator ” by William Bernstein. If you want to keep it simple and get a good starter book on investing then read ” The Bogleheads’ Guide to Investing ” by Taylor Larimore , Mel Lindauer, & Michael LeBoeuf.

However, no matter how many books you read, the hard part of passive investing is selecting the correct asset allocation of index funds that meet your risk tolerance. After doing that then you need to have the emotional discipline to stick to your plan and periodically rebalance it to make sure that your portfolio continues to meet your desired risk/ reward profile. Also because the industry continually evolves, there are new index alternatives to choose from. Some are an improvement and some nothing more than rip offs that are too risky and too costly.

This is where Alhambra Investment Partners comes into the picture. As a fee based only investment advisory firm we have a fiduciary responsibility to our clients. We earn no fees of any kind from the products we use to construct your investment portfolio. So turn off the noise of CNBC and avoid the clutches of Wall Streets army of commission based sales forces and contact Alhambra Investment partners to see if the strategic approach of using no load very low cost passive index funds to construct a portfolio that reflects your risk/reward profile and meets your desired long term investment needs makes sense to you.