Recently, a savvy client asked what would happen if every investor subscribed to passive investing strategies as a wealth management solution; in other words, what if everyone indexed?
Given the advantages of indexing, this question didn’t come as a shock.
After all, wealth management strategies based on passive indexing offer a number of advantages, including built-in diversification, lower costs and a decreased tax burden. So what would happen if everyone was in on this “secret?”
The answer may surprise you.
Why Our Wealth Advisors Advocate Indexing
Indexing offers a number of advantages over active management, including better performance. Over a 5 year period ending in 2012, about 90% of active equities funds failed to beat their benchmarks.
What if More Investment Professionals Recommend Indexing?
Given the overwhelming empirical data, it would only make sense for more wealth advisors to advocate indexing… but in a nutshell, don’t worry about it -- it’s not going to happen in your lifetime.
After all, the evidence (and logical thinking) that supports passive investing has been around for decades, and passive investments have widely available for at least 20 years. In the 1990s, passive investors held about 20% of market assets; today, that figure has increased to about 30%.
What Other Financial Strategies Contribute to Market Efficiency?
The buying and selling of stock by the company itself falls among the many forces that ensure prices reflect intrinsic values. For instance, when the market declined abruptly after the World Trade Center attacks in 2001, stock buy-backs surged, as companies realized that stock prices weren’t in sync with reality.
Buy-backs boomed again from 2004, hitting a high three years and pushing the Dow above 14,000 for the first time. In 2013, more than $286 billion in buy backs helped buoy the market further, an 88% increase over 2012.
Given the forces working to keep the market efficient, it’s not clear exactly what an extreme-case scenario would look like. If all of the money entering and leaving the market were indexed, would relative stock prices freeze? While it is a fair question, it is also a rather hypothetical as we are not seeing a rush into a passive-style approach. No, the average investor has become too saturated my the financial media to see the facts staring him or her straight in the face.
And if the thought of passive management seems a little too easy - like you’re taking a free ride on the research of others - knock it off. That’s what’s known as unearned guilt, and there’s no place for it in your effective and effecient, passive-style, investment portfolio.