Futures Edge Podcast: Decoding the Passive Bid in Markets
Investors have shifted their strategy in recent years. Rather than actively buy and sell stocks, shifting their mix over time, they’ve taken a passive approach. That’s been made possible with the rise of index investing.
The philosophy is simple. Why buy any one stock and be subject to a specific company risk when you can buy the entire market at once? Today, most investors have access to ETFs that offer nearly no cost for market exposure.
Since most active traders fail to beat the market over time, simply matching the market is a huge improvement. However, the rise of passive investing brings with it a different set of challenges.
For starters, most market indices are built around a weighting system. That means that passive investors are buying an index where a few big positions can dominate the index.
Currently, S&P 500 index investors have about a 28% weighting in the so-called Magnificent Seven big-cap tech stocks. That weighting is likely to rise as passive money flows in week after week.
In theory, if one of those stocks sells off heavily, it could mean a major index decline. And it also means that smaller and potentially faster-growing companies are underrepresented in a portfolio.
Investors should be aware of both the advantages and the dangers that passive investing provides today. Especially given the rise in passive investing for retirement funds.