How and when to use passive indexing strategies without following the crowd.
In this episode you’ll learn:
- How big is indexing and why has it taken so long to catch on.
- What areas has active management done well.
- What are ways we can index without following the crowd.
Show Notes
Passive investing continues to captivate global audience – Pension & Investments
Bogle Sounds a Warning on Index Funds – Wall Street Journal
The Future of Corporate Governance Part I: The Problem of Twelve – John C. Coates, IV
Morningstar Active/Passive Barometer
Yes. It’s A Bubble. So What? Rob Arnott, Shane Shepherd, Bradford Cornell – Research Affiliates
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365: Why Some Asset Bubbles Don’t Burst
390: Are BlackRock and Vanguard Too Big and Powerful?
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Episode Summary
There has been much debate on whether or not including index funds within one’s portfolio isn’t just becoming one of a large herd of passive management investors. Which is better? Active management of one’s investments or pitching in with the steadily growing passive form of indexing? In this episode, host David Stein untangles the statistics regarding indexing and whether or not investing in the index market should label you as a herd member.
Reasons for the slow, but steady, spread of index funds
Indexing has been around for quite some time, and some may wonder why it has taken so long in gaining speed as a popular investment. Thankfully, David lays out the history.
- Active management had a strong root in the investment world, and the idea of passive management seemed strange and untrustworthy. Sometimes basic concepts are slow to be accepted.
- Many thought that they could easily hire an active manager who could outperform indexing. David points out some surprising statistics, however, that show this trust to be heartily misplaced.
- Many ignored the drag that advisory fees have on the performance of their active managers’ investment decisions. It may just be a 1% fee, but the accumulative effect is often overlooked.
We can use passive management of our index funds without following the herd
Objection to the herding mannerisms of some indexing doesn’t mean that all indexing is herd behavior. David points out that passive management is entirely possible without becoming one of the crowd. There are several steps one can take to diversify one’s portfolio with index funds while keeping aloof of the masses. Listen to the entire episode for the details on how to accomplish these steps!
- First, don’t index everything in your portfolio. Keep it diverse. Know when active management is better than the passive alternatives.
- You don’t have to own weights in the large FAANG companies, such as Facebook, Apple, Amazon, Netflix, and Google. ETFs may be a better option for such companies, allowing you to trade on the exchange when the market takes a dip.
- Add non-index return drivers onto your portfolio. David gives a case study and explains that understanding what drives the returns on our investments informs us of the outcome.
- Lastly, just don’t follow the herd with your index funds. Be aware of how the market is moving.
An apples to apples comparison of active managers to passive management
Taking a look at large to small-cap blend assets, David highlights a comparison study which explored active and passive funds in the US. The evidence was overwhelmingly for the use of passive funds, as only a small percentage of active managers out-performed their passive counterparts. While foreign funds provided a somewhat stronger case for active managers, the question still remains as to whether it is worth it to spend time and money finding an active manager who can and will consistently outperform. How long do you give an active manager if they aren’t competing with passive management? David hashes out the numbers and gives solutions to navigating when and where to use an active manager and how to wisely discern which form of passive management to use.
The indexing herd exists, but we don’t have to be a part of it to index
As David points out in this episode, there are options. We shouldn’t ignore the statistics that show indexing to be a highly successful form of investment. Sometimes, active management just doesn’t cut it. Should your entire portfolio be made up of passive investments? No. But index funds are a healthy and steadily growing way of diversifying your portfolio with many benefits to consider. Don’t want to be just another head in the herd? The answer is simple: just don’t follow the herd. For the numbers, case studies, and developed explanations of this important topic listen to the entire episode!
Episode Chronology
- [2:25] Do all index investment followers herd?
- [4:13] Why it has taken so long for indexing to become established.
- [11:05] Comparing the statistic of active management to passive management.
- [16:14] Keeping your portfolio diverse while indexing.
- [19:54] Example of a return driver outside of indexing.
- [24:54] Steps to take to keep from following the herd.
