By John Persinos
Welcome to my video presentation for January 18, 2021. Today is Martin Luther King's Birthday, a national holiday. The New York Stock Exchange and the NASDAQ are closed to honor the slain civil-rights leader.
I'm taking a break today from covering the daily gyrations of the markets to focus on two related themes: "passive investing" and robo-advisors.
The following dialogue comes from the 2003 movie Terminator 3: Rise of the Machines.
John Connor: "You don't feel any emotion about it one way or another?"
The Terminator: "No. I have to stay functional until my mission is complete. Then it doesn't matter."
That verbal exchange could have come from the trading desk of any large asset manager. Machine trading has conquered Wall Street.
Be on your guard. The trend toward putting investments on auto pilot could pave the way for a crash.
Individual investors who want to profit from the markets but don't see themselves as stock-picking wizards are opting instead for exchange-traded funds (ETFs) and index funds. These vehicles are managed via software algorithms. Hence the term passive investing.
ETFs that track financial indices have become a major factor for the recent volatility in stocks. These funds act as accelerants, up or down. They could make the next downturn worse.
During the 2008 global financial meltdown, regulators weren't prepared for how derivatives and other quant strategies worsened the crisis. The 2010 flash crash occurred as a result of algorithms and automated programs that manipulated the market. The pandemic-induced market plunge of February-March 2020 also was exacerbated by program trading.
Wall Street seems to have learned nothing. Despite these risks, there's been a proliferation of passive funds that track indices cheaply and others, called "smart beta" investments, that mimic elements of what humans do at far less cost.
Index funds and ETFs charge annual fees that are only a small fraction of what an actively traded fund charges. The latter need highly paid "talent" to conduct research and conceive strategy.
Since 2000, investors have removed $2.5 trillion from active funds and plowed roughly the same amount into passive ones. About two-fifths of the global industry's equity assets are managed passively, up from nearly zero in 2000, according to research firm Sanford C. Bernstein.
The popularity of passive funds has concentrated financial clout into the hands of BlackRock (NYSE: BLK) and Vanguard. They're the two biggest providers of ETFs and index funds. Combined, they hold $10.5 trillion in assets and control 65% of the 1,700 ETFs in existence.
Average investors gnash their teeth during huge market swings. The folks at BlackRock and Vanguard impassively gaze at computer screens. There are no portfolio managers yelling market orders. Software programs are doing the work. No human emotions are involved. Machines are in charge.
Read This Story: IBM Watson's Stock Picks
This transition on Wall Street from human to machine has been unfolding for many years. The following chart shows the distribution of passive and active ETFs worldwide since 2011. It's projected that by the end of 2020, 31% of global ETFs were managed passively.
Source: Statista (*projected)
It's easier to make money with passive funds during a bull market. The true test comes during a market crash. That's when investors face a strong temptation to sell, which is usually a mistake. It's during times of turmoil that the active approach can make a big difference.
As retail investors continue their march toward passive investing, I remain an advocate of active investing. Don't get me wrong: pooled investment vehicles, such as mutual funds, ETFs, and closed-end funds, still belong in portfolios. I don't want to settle, though, for index performance. At Investing Daily, we strive to beat the market. The wisest stance is a combination of passive with active.
To be sure, index funds and ETFs involve less stress. With an index fund or ETF, you're not tempted to shift your funds from a loser to an ostensible winner. You're liberated of desperate efforts to buy low and sell high. Emotion is removed from the equation.
The downsides to passive investing? Well, for starters, it's really boring. But more importantly, your chances of getting rich through the passive approach are just about zilch. And besides, it's not truly passive. You need to decide which fund is appropriate for your needs and goals; you also need to determine asset allocations.
Losing the human touch…
In a closely related trend, we're seeing the rise of automated investment services called robo-advisors. Introduced a few years ago, these services are being aggressively sold and are quickly grabbing market share. In 2015, they managed only half a percent of invested assets. However, that number is estimated to have reached 5.6%, or more than $2 trillion, by the end of 2020 (see chart).
Robo-advisors are computer-based systems that set up asset allocations based on answers to a dozen or so questions about your age, risk tolerance, years to retirement and other basics.
Over time, the investment mix grows more conservative (e.g., there's a greater emphasis on safe income stocks) as retirement draws closer. In this way they're like target-date funds.
However, robo-advisors lack a personal touch. Their automated systems don't account for a client's personality or changing circumstances. Customized advice can add value, especially for complex situations or during bear markets, when a good financial advisor can be a voice of reason.
I'm confident that we face a continued bull market in 2021, but the economy remains battered by the coronavirus outbreak and equity valuations hover at historical highs. In this bifurcated situation, an active approach is more important than ever. It's easy for the herd mentality to misread events.
Read This Story: Sending the Wrong Signal
My view? If you're not making your own decisions, you're burying your head in the sand. There are proactive measures that not only protect your portfolio but also retain a growth trajectory. For example, in this frothy and risky market, you should rotate toward safe havens, such as stable dividend-payers. (For our dividend map of the best income stocks, click here now.)
As the major stock market indices continue to hit record highs, we'll probably experience volatility in the pandemic-afflicted year ahead. Our flagship publication, Personal Finance, recommends that you currently maintain a diversified portfolio with the following allocations as a rule of thumb: 45% cash, 30% stocks, 15% hedges, and 10% bonds.
But you can't expect this sort of balanced and carefully calibrated approach from robo-trading. During a market downturn, passive investing results in automatic losses.
Many traders follow the lead of the greatest investors, especially Warren Buffett and his Berkshire Hathaway (NYSE: BRK.A, NYSE: BRK.B). The Oracle of Omaha once famously said: "Be fearful when others are greedy and greedy when others are fearful." Does that sound like a "passive" stance to you?
The Key Takeaway: Don't put your portfolio on automatic pilot. Be sure to perform regular performance reviews of your investments and place performance in the wider context of your long-term policies as well as overall market conditions.
Care to weigh in on the debate between passive and active investing? Send me an email: mailbag@investingdaily.com
John Persinos is the editorial director of Investing Daily. You can reach him at: mailbag@investingdaily.com. To subscribe to his video channel, follow this link.
Tidak ada komentar:
Posting Komentar