Every bubble ends.
This one will be no different.
History has proven investors will grow too confident, plow too much money into something, get lulled into an undue state of self-confidence, and then have it collapse.
Right now $3.6 trillion has been put into this single idea (odds are you’re in it too), it’s only a matter of time until it implodes, and, as I’ll show you below, there’s a simple way you can avoid any fallout when it all blows up.
Is Stockpicking Dead?
Honestly, I never thought this idea was a good one.
Now that it’s caught on so massively, I’m sure it’s not.
The idea is index funds and passive index investing is the best way to long-term riches.
It’s a simple concept.
Actively-managed mutual funds are terrible.
They consistently underperform the markets. Depending on the study, as many as 95% of mutual funds fail to beat the markets over a five or ten year period.
And they normally charge 1% to 2% of assets each year for the service of failing to even match the markets.
They’re just awful and investors now have an increasingly popular alternative in passive index funds.
These are the funds that just buy every stock in the market.
There’s no discrimination at all.
Cheap stocks. Expensive stocks. Just get them all.
They say things like, “Don’t try to beat the market, be the market.”
They’ve exploded in popularity over the last few years to the point they’re now the fastest growing financial asset class in the world.
That should be a warning sign right there.
But the numbers are truly huge.
In all, passive index funds have $3.6 trillion.
The original and now largest passive index fund, Vanguard 500 Index Fund which invests exclusively in the S&P 500 stocks, now has $469 billion in assets under management.
The numbers are still growing too.
Researches at Morningstar estimated that investors pulled out $317 billion of money from traditional, actively-managed funds and while putting $373 billion into passive index funds.
On the surface, I don’t blame passive index investors for jumping in either.
Passive index funds work quite well as an alternative to traditional, actively-managed mutual funds.
The stats are everywhere.
For example, the world’s largest passive index fund, Vanguard 500 Index Fund, beat 84% of all actively-managed mutual funds in 2014.
Naturally, the index will beat most mutual funds in most years.
Most actively-managed mutual funds are just terrible.
It’s like a college football team playing a high school football team, the college team is going to win easily.
The former has so many more advantages over the latter.
However, that doesn’t make them professional-level quality at all.
That’s where the fatal flaw of passive investment funds -- and their eventual undoing -- come into play.
“I’ll Sell When I’m Rich”
The problem with stocks, mutual funds, and passive index funds isn’t the assets themselves.
They’re just investment vehicles meant to be bought and sold over time.
The problem with all of them including passive index funds is the investors in them.
Passive index funds do not avoid the problem of investors’ emotions.
In a way, they actually make them worse.
Passive index funds give their investors a feeling of safety and security.
They’re diversified. They beat 80% or 90% of actively managed funds every year. They’ve also risen largely from one of the steadiest and most consistent bull markets in history.
What do you think will happen when the next bear market comes (if it hasn’t already started)?
Passive index investors will be in the same position investors who buy individual stocks will be -- unprepared emotionally.
However, the passive index investors will be far less experienced, far less prepared, and will not have learned how to cut losses early.
I picture the average investor as someone who buys in with an exit strategy of basically, “I’ll sell when I’m rich.”
They have no exit strategy if things don’t go as planned. And without an exit strategy, both passive index investors and individual stock investors will sell at the point they can’t take the pain of losses anymore which is usually the worst possible time to sell.
If you learn to make an exit strategy before you buy, you to will beat the most actively managed funds too. And when the next bear market begins, you’ll be beating passive index fund investors too.