Columnists John Grace Opinion

ON THE MONEY: Investing passively can have negative impact

Amidst the stock selloff in December 2018, where the market was off 20% according to Yahoo Finance, my friend Jeffrey Gundlach sounded the alarm on passive investing. 

“I wouldn’t advise anyone to be a passive investor,” Gundlach said in an August 2019 CNBC interview. “My strongest advice is to not invest in passive U.S. equity funds. I think in fact that passive investing and robo-advisors are going to exacerbate problems in the market because it’s herding behavior.”

The investor made famous by “The Big Short,” Michael Burry, told Bloomberg News that he sees “a bubble in passive investors.” Burry cites problems happening because “the pillars of passive investing, exchange-traded funds and index based assets, mostly focus on bigger companies.

“This puts downward pressure on the stocks of smaller companies and has effectively orphaned smaller value type securities globally,” Burry added.

Over the last decade, passive investing has increased greatly in size and popularity. The good news is that investors have learned to avoid timing the market and allow for time in the market. 

But what works for those who don’t need the money could be the same practice that decimates investors who are taking money out of their portfolios because they have to or must do to satisfy distributions required by the IRS from traditional retirement accounts. 

The traditional “buy and hold” mantra, no matter what, can be an investor’s friend when you can add to your accounts or avoid taking money out of your portfolio. But if there is another financial calamity that erases 57% of your equity portfolio, as you have seen in the past, and you take a withdrawal of a modest 3%, what was $1 million at the beginning of the year becomes $400,000 at the end of the year after the severe market loss of $570,000 and a modest income of $30,000, totaling $600,000.

Today’s current market environment illuminates a number of recession indicators flashing and investors are becoming increasingly nervous. Money managers have argued that passive strategies can set up investors for major losses if they sell in an unexpected market downturn.

With more than 40 years in the securities business, it is my observation that the bottom line for the industry is to horde assets and collect fees.

Instead of “stocks for the long haul” or “hold and hope” or “buy and hold no matter what,” when you are taking income your first priority needs to be how do you minimize losses.

We all enjoyed a great Super Bowl LIV and I did not miss the Patriots on the field at all. But here’s what we all know about football teams, all of them, there are no exceptions.

There are 32 teams in the NFL and prior to 1941 virtually all football players saw action on both sides of the ball, playing in both offensive and defensive roles, according to the National Collegiate Athletic Association.

Today, every football game is played between two basic teams of 11 players. There are 11 players on offense who are trying to score and 11 players on defense who are determined to keep the other team from scoring (and to take the ball away from them).

The special teams play in kicking situations. As the economist in your home, take the time now to fill in the blanks with your offense and defense investment strategies.

As the market gyrates looking for direction, now is the time for investors to follow the lead of every football team. Establish players or investment vehicles that can make money in an up market. And add to your roster investment vehicles that can help you minimize losses in a bad market.  In preparation for these Turbulent 20s, it is good strategy to see how you might win by losing less.

John L. Grace is president of Investor’s Advantage Corp, a Los Angeles-area financial planning firm that has been helping investors manage wealth and prepare for a more prosperous future since 1979. His On the Money column runs monthly in The Wave.