Are You Swimming Naked?
The world has been on a bull market tear since the financial crisis of 2008. We are still seeing record highs in various indices throughout 2017. The indiscriminate buying in passively managed funds has been a serious contributor to this phenomenon and it will likely be the reason the next market crash is more severe in terms of loss and recovery time.
Passive investments don’t look at price. They don’t look at earnings. Money comes in - they buy indiscriminately. Not the best names, not the best companies. Passive investing ignores value.
Here we see a chart of the Russell 2000 Index. This is an index of approximately 2000 stocks, that are considered small relative to other indices. Over 30% of the stocks in this index have zero or negative earnings. But if you own a passively managed fund that tracks the index it will still buy these names that are make no money at all, or worse are losing money.
Why are investors falling for this?
The media would have you believe that fees are the only factor you should be looking at when it comes to investing. The focus has been on low cost management. With most markets illustrating double digit annual returns, why would investors worry? Market volatility is low. Borrowing costs are low. There is little sign of inflation. Investors are feeling pretty good about themselves. All this is driving money into passive investments. Investor complacency is starting to build. They are being led to believe that markets only go straight up.
As the saying goes, “A rising tide floats all boats.” But there is another saying, “Only when the tide goes out do you discover who’s been swimming naked.” Warren Buffett.
If your investing passively … you’re swimming naked.
For more information on the impact of passively managed money on markets and investment returns read The Case For Active management, The Upcoming Market Crash, It's Gonna Be Worse, In Case You Forgot Rule Number One, Is This Your Doctor?, & You're Behaving Badly.
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