A Warning Shot For Passive Investing
A Warning Shot For Passive Investing by Lance Roberts – Real Investment Advice
Last week, investors received a “warning shot” about the dangers of “passive indexing.”
While the idea of “passive indexing” sounds harmless enough, we have spilled a lot of ink on this site digging into the relative dangers of it.
The biggest risk to investors is when “passive indexers” turn into “panic sellers.”
We witnessed it all first-hand last week.
The “sell off” proved our previous premise of the flaws of “passive investing.”
“While it is believed ETF investors have become ‘passive,’ the reality is they have simply become ‘active’ investors in a different form. As the markets decline, there will be a slow realization ‘this decline’ is something more than a ‘buy the dip’ opportunity. As losses mount, the anxiety of those ‘losses’ mounts until individuals seek to ‘avert further loss’ by selling.”
I have also stated that while “robo-advisors” are the new “shiny toy” for the markets to play with, and inexperienced investors to be lured into, when a crash does come, individuals will not be willing to just “ride it out.” To wit:
“The websites of two of the country’s biggest robo-advisers — Wealthfront Inc. and Betterment LLC — crashed on Monday as the S&P 500 Index sank. Complaints quickly spread across Reddit and other internet sites from people who had trouble logging onto their accounts.”
Yea….it’s that psychology thing.
Individuals just simply refuse to act “rationally” by holding their investments as they watch losses mount.
This behavioral bias of investors is one of the most serious risks arising from ETFs as the concentration of too much capital in too few places. But this concentration risk in ETF’s is not the first time this has occurred:
- In the early 70’s it was the “Nifty Fifty” stocks,
- Then Mexican and Argentine bonds a few years after that
- “Portfolio Insurance” was the “thing” in the mid -80’s
- Dot.com anything was a great investment in 1999
- Real estate has been a boom/bust cycle roughly every other decade, but 2006 was a doozy
- Today, it’s ETF’s and Bitcoin
Risk concentration always seems rational at the beginning, and the initial successes of the trends it creates can be self-reinforcing.
Until it goes in the other direction.
While the sell-off last week was not particularly unusual, it was the uniformity of the price moves which revealed the fallacy “passive investing” as investors headed for the door all at the same time.
“With everyone crowded into the ‘ETF Theater,’ the ‘exit’ problem should be of serious concern. Unfortunately, for most investors, they are likely stuck at the very back of the theater.
However, I am suggesting that remaining fully invested in the financial markets without a thorough understanding of your ‘risk exposure’ will likely not have the desired end result you have been promised.
As I stated often, my job is to participate in the markets while keeping a measured approach to capital preservation. Since it is considered ‘bearish’ to point out the potential ‘risks’ that could lead to rapid capital destruction; then I guess you can call me a ‘bear.’
Just make sure you understand I am still in ‘theater,’ I am just moving much closer to the ‘exit.’”
As we have previously discussed, when the “robot trading algorithms” begin to reverse, it will not be a slow and methodical process but rather a stampede with little regard to price, valuation or fundamental measures as the exit will become very narrow.
That Wasn’t THE Crash…
Fortunately, while the price decline was indeed sharp, and a “rude awakening” for investors, it was not a “crash.”
It was just a correction within the ongoing “bullish trend.”
But nonetheless, the media has been quick to repeatedly point out the decline was the worst since 2008.
That certainly sounds bad.
The question is “which” 10% decline was it?