Throughout January, stocks continued to surge, building on a multi-year trend of swelling valuations that goes back to the wake of the financial crisis.
And, as I discussed in my last article, there’s reason to believe 2018 will be another rock solid year, despite the volatility that spooked investors in the early part of February. Remember, bull markets, unlike people, don’t die of old age, even as this one is particularly long in the tooth.
Indeed, the recent tax reform package should boost corporate earnings and give consumers more money to spend. Meanwhile, the jobs picture continues to improve and wages, which have languished during much of the recovery, grew at the fastest pace in eight years, according to January’s labor report.
Though some are concerned that the Federal Reserve could hike interest rates to stave off inflation -- and, in the process, squelch the flow of easy money that has, in part, fueled rising markets -- these factors portend mostly positive things for equities.
But, while we’re still in a period of near-uninterrupted gains and optimism remains high, investors can’t become complacent. Right now -- when it seems very little can derail the market's upward momentum -- is exactly the time to consider whether your portfolio is loaded with too much risk.
A rising tide may indeed lift all boats, but not every boat can navigate the rough, choppy waters that crop up when the tide turns.
That aphorism is useful in thinking what can happen with passive funds, which have become the rage in recent years, capturing billions of dollars of investor inflows.
But the downside of passive strategies is that they can miss out on opportunities to experience higher returns during booms or avoid the brunt of the damage during busts.
The Passive Approach And Its Shortcomings
The lure of passive investing is clear: It’s a simple way to control costs. Think about market unrest as a wind- and rain-packed storm. Passive managers do nothing to avoid the coming onslaught, staying outside rather than seeking shelter. They get drenched as a result. The flip side is that, once the sun peers through the clouds again, they are the first to enjoy the nicer weather. That’s the essence of passive management: Stand pat during turbulent times, knowing that market storms will eventually pass.
That may work great in theory, but, in practice, this approach presents a risk. This typically happens in one of two ways -- or, unfortunately for many investors, in concert with one another, which over multiple up and down cycles can have enormous implications.
One is that, because passive managers do very little maneuvering, investors may not enjoy the highest of the highs but still endure the worst of the lows. Some passive funds, for instance, have recently trailed the S&P 500 Index thanks to the lagging performance of value stocks combined with the outsized gains of the FAANGs. Compared with others, this has resulted in an erosion of investment capital for anyone invested solely in such funds.
