Passive Indexing is the Rage - Should it be?
This article first appeared in the January 2022 editions of Toronto's Post City Magazines.
In recent years, many investors have increasingly moved their investment portfolios towards passive index investing. This means they own every company in a stock index, including the good, the bad, and the ugly. So, if some stocks become overvalued, the investors own them. If some companies are not actually earning any profits, the investors own them too. The same goes for companies with declining revenues. When your portfolio mimics a broad stock index, you own any companies swept up in overexuberance around fads and trends. And with passive investing, you own any companies using excessive debt to fund their operations and growth.
Few investors notice these problems when stock markets are doing well, and the rising tide lifts all boats. There is no denying that for the last decade, passive index investing has performed better than the average investment manager. But this has not always been the case, and this will not necessarily be the case going forward. There will be times when the tide goes out.
Some portfolio managers do not believe in passive index investing. Rather than blindly own the whole market, some prefer to pick each company based on fundamental merits, while paying close attention to valuation. You might feel better knowing your investments are guided by a portfolio manager that seeks to keep your entire portfolio invested only in profitable companies, and only in companies with safe amounts of debt. You might prefer a portfolio manager that invests in companies with long histories, and avoids stocks swept up in fads, trends, and short-term sentiment. It might pay off to use a portfolio manager that seeks attractive opportunities that do not represent a high proportion of prominent stock indexes.
No style of equity investing is guaranteed. Both passive and active investments are subject to risks and may lose value. And regardless of the approach you follow, you need to understand the fees and costs. All things considered, despite the popularity of passive index investing, it might make sense to talk to a traditional value-oriented portfolio manager before deciding what approach is right for you.
Until next time!
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