Review: The ideal ‘buy high, sell low’ situation could be taking shape in the stock market

Well, this is a new one. This article is arguing that passive investing isn’t actually passive, because if the market drops enough investors will panic. Essentially he’s arguing that there’s no such thing as passive investing because investors are bad at building portfolios around their risk tolerance.

I’ve never run across this argument before, but to be clear, it’s completely ridiculous. Of course passive investing exists even though most investors are bad at investing. This is like saying that Spain doesn’t exist because your flight to Madrid was delayed.

There are all sorts of better arguments against passive investing (admittedly, not a high bar). They’re wrong, but they’re wrong in interesting, or at least understandable, ways.

To get back to the article’s argument, passive investing means tracking the market on the way up, as well as on the way down. But so does active management.

There’s no evidence that active management does anything but add noise to the market returns that you get for putting your money to work in the financial markets. There’s certainly no evidence that active management does any better than passive management.

Active managers try to point to downside protection as their saving grace. And certainly, a lot of active managers will shift to cash during prolonged bad periods in the market. This makes them appear to do better (though the effect is often wildly overstated).

But market recoveries happen incredibly quickly, and managers that shift to cash to avoid the bad stuff often end up missing the good stuff. This is why broadly diversified, disciplined, risk tolerance-appropriate portfolios often do better over the long term.

And the long term is what you should care about. When you are investing for your retirement, what happens over the next quarter, or even the next year, isn’t what determines your success or failure. Markets go up and down. We know this. But over the long term, disciplined investors have done pretty well for themselves.

To see how this works, take a look at our ebook Investing Through the Decades

 

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