Gray Financial Risks
I love passive index investing. I love the intelligent simplicity of it, I love how it shows clearly that many asset managers are actually hurting clients more than helping them, and I love how it frees up professional resources to dedicate to more impactful areas of financial planning. Passive index investing has been endorsed by none other than the Oracle of Omaha, Warren Buffett, often said to be the greatest investor of our time.
However, some time ago, I began seeding an idea of the possible dangers of passive index investing. I ended the last blog by asking hard questions about S&P 500 index funds including questions like, what if these funds have created prices that no longer correspond to the functional value of the companies in the index? If that’s true, then are we no better than the people who were willing to pay exorbitant prices for tulip bulbs in the 17th century?
A quick reminder/disclosure is that this column is not investing advice for you! You're too unique to take general advice from a column. Back to the S&P 500.
It seems almost certain to me that the explosion of passive index fund investing has caused market price distortions. Investopedia defines a market distortion as interference that significantly affects prices and, in some cases, risk-taking and asset allocation. Does that mean you should sell every stock you own? No. Does that mean you should sell your S&P 500 index fund? No. And I admit again as I did last week, most of my clients hold S&P 500 index funds.
It does mean there is a risk inherent in passive index investing that is not there with active investing that relies on analysis to determine the merit of a particular investment. In simpler terms, investors can’t know if the price they're paying is “right” or “fair” if there is no investment analysis. So what action do you take?
Unfortunately, it’s not simple. It depends on YOUR risk tolerance and YOUR worldview. The longer we live in this world, the more readily we are able to admit this world is hardly black and white. It’s mostly gray. Our decisions are tough because every choice has pros and cons.
Take the pandemic response of the past 2 years. There were certainly a lot of physical health risks mitigated by shutting down the entire local economy, or US economy, or global economy. However, at what cost? It certainly came with a huge economic price tag to shut down everything. But we now see there were significant psychological and emotional price tags as well.
So when the next virus hits, do we shut down everything to ensure we keep infections and deaths to a minimum, or keep everything open to be sure we don’t pay too steep of psychological and economic costs? I have an opinion on what I believe it’s right, but I certainly understand when someone has a different perspective, because they are different from me!
Gray. Not black and white.
For your financial life, don’t pretend you can ever run away or hide from the risks of this world. They are everywhere. Instead, get serious about identifying the risks, and do serious research or get serious help about worst case scenarios and options for you and the ones you love.
Finally, as you consider these risks and scary circumstances, one final piece of advice: beware of annuity salespeople.