Passive Index investing’s pitfalls are on full display.
Just look at the Dow 30 to start.
- Buy stocks of great companies and hold them
- Be a long-term investor
- It’s time in the market, not timing the market
- Own the whole market
- Ride out the bumps
- 20% declines in stock prices are healthy
- The Easter Bunny is real
- Martians live among us
The first six bullet-pointed items above are all investment myths that are in the process of being busted. The other two are non-investment myths that were long-ago busted (spoiler alert!). So we will focus on the first six, which have more relevance to investors anyway.
When you put that top group of six together (and many investors do), they create an attitude about and approach to investing that is no longer a fit for most investors. I say that not because there is no merit to each one of them…there is. But investing for real-life objectives like a desired lifestyle in retirement, funding a home or kids’ education, etc. has been greatly oversimplified.
Active management is right up there with George Carlin’s 7 Dirty Words, and passive investing, which seeks to know nothing about what one is investing in or what its merits are, is all the rage. Perhaps in the new bear market for stocks, the rage will turn back against the machine, so to speak. And it is precisely the machines that are at the heart of my concerns.
You see, so much of daily trading volume on the stock exchanges is driven by factions that are not too concerned with the “fundamentals” of what they are buying. About 18 months ago, JPMorgan published a report that said fundamental traders accounted for only about 10% of trading volume in stocks.
That means that “long-term investors” have two choices. They can completely ignore the disruptive impact on stock prices caused by algorithms, hedge funds, ETFs and the like. Or they can acknowledge it, accept it, determine how to manage it, and perhaps even exploit it to your benefit.
But as with past bear markets, when the going gets tough, investors get reminded that buy-and-hold investing the “old fashioned way” is only for those with iron guts and extreme patience. As the years progress, I see that people want an investment process with simplicity, low cost and an infusion of technology into the process. But above all of that, they want to know that the wealth they have accumulated will not be taken away by an inanimate object…the financial markets.
Here is a recent example of why I think this is such a critical investment choice, and one that needs to be made BEFORE an investor continues in dream-land about buy-and-hold and passive investment strategies. This shows the 30 stocks in the Dow Jones Industrial Average, and the magnitude of their price ranges (from high to low) over the 52 weeks ended 12/21/18.
As you can see, the average Dow stock fluctuated by over 27% over the year. Most were around that average, and the lowest was still over 18%. This is not a 2018 phenomenon. I think it has every bit to do with the mix of “players” in the stock market today, and how their motivations are very different from the white-shoe Wall Street crowd of yesteryear.
- Individual stocks are volatile, so determine how much of that volatility you are willing to take in the name of “long-term investing.”
- While ETFs, as more diversified vehicles, can help reduce volatility, they often do so in a magnitude that fails to effectively clamp down on big losses.
- Managing portfolios in a manner that prioritizes the actual objectives of the investor and treats the stock market as a tool for getting what that investor wants, is the modern and effective way to approach stock investing. As kids, perhaps some folks truly believed in the Easter Bunny and Martians. But as we age, we figure out what is real and what is not. I think that evolution will increase rapidly as the friendly financial market conditions of the past decade become much more challenging.
For research and insight on these issues and more, click HERE.
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