I read an article about passive investing over taking 60% of the market, and an additional 20% being traded by robots. Nobody knows what this means. It’s a brand new phenomenon. The market index funds are up 39B while the active funds are bleeding to death down 90B.
Index funds are not index funds. They are index tracking funds. Total Stock Market does not hold all the stocks in the market. Last time I looked it held 180 stocks which are weight adjusted to track the market. I’m not sure what it holds today. Passive investing is built on the idea you buy and hold, and sell a little dab once in a while to buy hamburgers, or live off the dividends or some combo of that. Passive funds are owned by relatively inexperienced investors who bought in a time of sustained growth out of proportion to the norm. Market averages are thought to be 90% higher than the trends predict, so people are used to the good life. It is absolutely unclear what would happen if the market crashed. Would people violate “Buy and Hold”?
In addition the funds are not the index but a small fraction of the index, adjusted. When the sell orders come funds are selling those few stocks in the tracking fund, not the index which will accelerate the volatility in those particular shares and distort the funds price compared to the actual index likely a distortion to the downside. If suddenly your VTI is trading below par what you gonna do? The market will regress to the mean at some point, we can only hope the regression is orderly and covered by rational sustained growth and not all at once.
The robots follow trends and are algorithms tuned to maximize profit. As trend followers they will go long OR short. It’s buy low sell high OR Sell high buy low, that’s how they make money and they are agnostic to which pair of profit makers to employ. So in the up trend they are your ally tending to add to up momentum, but in the down your enemy if your a buy and hold type since their position becomes anti-momentum to your position. Shorting the market increases volatility and 20% is a pretty big short compared to 60% buy and hold. In addition the regular speculative traders will tend to follow the trend aka don’t fight the tape, so suddenly 40% of the market is aligned against you, where as 40% prior was aligned with you.
I read several Bogel books and articles and he was worried about this when indexing was only 20% of the market. If someone as smart and plugged in as Jack was worried who am I to blow that off?
What to do, what to do? First off consider your risk profile. A 80/20 has lot more to loose in this kind of crash than a 50/50. Don’t presume “it will come back” as that is unclear to me. The market is already something like 90% over valued. If 60% get burned it’s very unclear 60% will return, and I think many will cut and run at any price adding to the volatility.
Own stuff less likely to sell. I own DFA funds through an adviser. You can only own those through an adviser, and a good adviser can stand in the way of your panic. The best antidote for volatility is owning the VIX unfortunately nobody can afford the VIX but professionals, long term because of the carry charges and the ETF are not a good stand in. The don’t really track the VIX very well. Own some GLD. GLD’s volatility tends to be in the opposite direction from stocks in a crash so the net is a reduction in volatility. Own some cash equivalent like a tangent portfolio. The tangent is mostly bonds so it’s volatility in a crash is very low and it gives you something to spend while waiting for the dust to settle. It’s like a security blanket.
One thing to remember is owning stocks is owning property. They are NOT cash. The more property you own the richer you are, so it’s a good time to buy some property when it’s on sale if you can stomach it. It’s also time to tax loss harvest, a different way to make hay while the sun shines. To tax loss harvest you need brokerage stocks so a brokerage account would be a good thing to own. May take a while to pay off but it’s always done so in the past.
That 60% passive index + 20% robots freaks me out.