Of Dollars and Data: Is There a Problem with Passive Investing?

One of the biggest investment shifts in recent decades has been the move towards passive investing. Today, over half of all equity fund assets are in passive funds. That’s over $13 trillion in assets.

Passive investments avoid the higher costs of moving in and out of individual stocks. Instead, passive investments look to buy an index. Consequently, these funds offer low fees that make it easier to match the market’s returns.

However, the rise of passive investing has some potential dangers. Since most market indices are valued by weight, larger-cap companies dominate indices. If the Magnificent 7 tech stocks sell off, the overall S&P 500 index could fall. Even if the other 493 stocks in the index rise.

As more and more capital moves into a passive investment, the more this concentration risk rises.

Given the hefty valuations in many large-cap stocks, this danger shouldn’t be overlooked. Plus, by investing in funds, individual investors are giving money managers voting rights in specific companies.

This could simply mean that fund managers “rubber stamp” corporate voting with management. Even if such proposals aren’t in the best interests of individual shareholders.

For now, passive investing remains a runaway success. But investors may want to look for equally-weighted funds to avoid stock concentration risk.

To view the full list of pros and cons to passive investing, click here.