The Problems With Passive Investing And Index Funds

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The Problems With Passive Investing And Index Funds

Index funds and other passive investment options have many investors joining the fray in recent years. According to a recent NYT article, Vanguard is receiving record inflows from investors than ever before 

In the last three years, investors have sunk $823 billion into Vanguard funds. The scale of this change is absolutely enormous – all other fund in the world combined only received $97 billion.

The public support for Vanguard funds has been incredible in recent years. The world’s greatest investor, Warren Buffet, has supported Vanguard’s profits. He has even said that Jack Bogle has done more for investors that any other person in history. 

This support is compounded by the under performance of active managers. From 2001 to 2016, almost all large-cap, mid-cap and small-cap fund managers underperformed their benchmarks, according to S&P Dow Jones Indices.

A question hanging over passive investments is that they have yet to be tested during a severe market plunge. After all, their success has really been a relatively recent phenomenon.

The fundamental issue is that passive investing puts investors in the driving seat. You can no longer trust your portfolio managers to ride out the crashes, you are now completely responsible. If the market were to crash, it is just you and the plunging markets.

The benefits of index funds are greatly reduced when you sell during a market crash, because you run the risk of incurring transactions fees and incurring capital gains taxes apart from a loss of capital due to the crashes themselves. 

This could easily place investors under a form of pressure that they have never experienced. They will be faced with question about whether to sell, or ride out the crash completely.

Conclusion
A severe market downturn will test these investing instruments and validate their overall effectiveness as investing options for the average investor.

Note: this post does not qualify as investing advice. It is the opinion of the author. Seek assistance from a certified financial advisor when you are making financial decisions.

2017-11-08T17:37:15+00:00 September 27th, 2017|Investing|
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