There is a general belief among investors that passive index investing is smart, safe and more importantly, widespread. A recent BlackRock study challenges the last part of that belief by noting that passive investing occupies just 7.4% or just over $5 trillion of the $68 trillion invested in the market.
On a worldwide basis, active buying and selling of securities is the real face of investing, according to BlackRock. As a result, due to low turnover and relatively small size, passive investing plays a tiny role in pricing of individual stocks.
Related: Dollar Cost Averaging
The Apple Example
BlackRock surveyed trading of Apple Inc. (NASDAQ:AAPLB) stock in July 2017 and discovered that only 5% of trading in Apple was related to ETF index trading. This despite the fact 331 ETFs worldwide held Apple shares.
The real Apple action took place among individuals, mutual funds, hedge funds and Apple itself. Put another way, index funds and ETFs “don’t have the potential to distort investment flows, create stock market bubbles, or conversely exacerbate a decline in market prices,” according to BlackRock.
Why Passive Investing Is Worthy
Just because passive index investing isn’t the tail wagging the dog, doesn’t mean it isn’t worthwhile. Passive investing is less expensive than active investing. Moreover, passive index fund investing typically beats out active fund investing by featuring low operating expenses and low portfolio turnover.
For retirement funds including IRAs and 401(k) accounts especially, passive index fund investments are generally considered ideal. While passive investing is a small % of overall investing, the fact index funds outperform their actively managed counterparts is causing assets to flow into passive investments at a greater rate than ever before.
Toward A ‘Passive’ Future
Despite the current state of affairs, plenty of investors fear passive investing strategies will eventually take over. Casual investors especially are in love with the idea of not paying high fees for actively managed mutual funds. The result has been declining enthusiasm for mutual funds and growing demand for index funds and ETFs over the past several years.
Passive investing is here to stay. In the past two and a half years more than 40% of new money being invested has gone into buying index funds. The idea that the money you invest will reflect the overall movement of the market is appealing. People don’t understand the “bits and pieces” of investing but they do understand what it means when the newspaper says the market had a good day.
A Passive Bubble
All this raises the question: Has passive investing reached a bubble? With so much money flowing into index funds, money managers wonder if this is destroying price discovery (the basic law of supply and demand that sets stock prices) in the overall market.
BlackRock says “No,” at least not yet. But what about the future” Active managers are certainly playing a less critical role in price discovery. Matthew Karr, manager of investment research at Fragasso Financial Advisors says, “As index funds increasingly take more market share, stable companies are seeing prices incrementally moved by investor capital inflows and outflows of passive strategies.”