The Capitalist Investor - Episode 19

Passive investing has been all the rage—while active management has been slammed over the last decade. Why is that? Why does passive investing fare so well? Listen to this episode of The Capitalist Investor to hear why we think the tides are turning. We are going to see a shift towards active investing.

Outline of This Episode

  • [0:16] Why passive investing has been so successful
  • [4:55] Understanding the rise of passive ETFs
  • [7:53] How to use “passive” ETFs to your advantage
  • [10:40] Digging into the holdings in the S&P 500 ETF
  • [15:25] The main argument for active investing

Why is passive investing all the rage?

Simply put, passive investing has done well over the last decade. It’s because all stocks seem to have gone up in the same sector at the same pace. At the end of 2019, the Russell 2000 Index was doing well—although 40% of the companies weren’t making money. In fact, they were losing money.

It doesn’t logically make sense, and it’s largely because trading hasn’t been based on logic. Traders haven’t been looking at the numbers. They’ve been making trades on hype, on cult-followings. Investors aren’t motivated to pay someone to actively manage their funds when the passive approach has given them steady returns—but that is going to change.

The danger of passive investing

In 2008 there were around 1,600 ETFs—now there are 7,000. We live in a day and age where you can “create your own ETF” just like Build-A-Bear. The S&P 500 ETF is an example of passive investing. Why pay someone 1% to manage your money when a target-date fund costs ¾ of a percent? Or when a robo-advisor charges ⅓ of a percent? The problem is these funds don’t get tactical at all. They do whatever the benchmark index is doing. We get it, it works—until it doesn’t.

Every business is experiencing severe cashflow crunches that will have a long-ranging impact. Fundamentals and balance sheets are about to become extremely important as part of your investing strategy. Guess what? Passively managed funds won’t get tactical. You’re going to need to strategize and pass up passive investing for active investing.

What active management can do for you

There are different forms of active and passive management. A simpler form of active management does use passive ETFs, but overweighting/underweighting different asset classes and sectors. You can overweight tech if you like tech, and underweight the energy sector if you don’t like it. Being tactical with ETFs is still a form of active investing.

The world is changing permanently. The way we live 6 months from today will look quite a bit different from 6 months ago. There are going to be winners and losers in the stock market—you don’t want to own the losers. That is why active management is so important. If you own an ETF under passive investing, you get stuck with the winners and the losers.

A deep dive into the S&P 500 ETF

The top holdings in this ETF right now include stock such as Rite-Aid,, Chewy, Etsy, Amazon, Kroger, Dollar General, etc. All of those make sense given the current state of our economy. But if you look at holding #20 on their list at a 1.6% weighting—you get Tiffany’s. Is the average consumer coming out of this pandemic looking to buy expensive jewelry? It’s highly unlikely.

Luxury items will be hit hard and slow to start back up again. As you go further down the list of this ETF’s holdings you see Carvana, Gamestop, TJ Maxx, L Brands, Foot Locker, American Eagle, Macy’s—the list of retail goes on. These stocks are NOT going to be on the list of winners in the coming months or years.

If you’re passively investing, you’re stuck with what you get. Choosing active investing now is picking a good entry point for a position you want to be in going forward. The decisions you make right now will impact the next two or three years. You want to get into the right investment trend before the rest of the market catches on—active investing is the way to go.

Resources & People Mentioned

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Episode 31:
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Episode 47:
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Episode 63:
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Episode 79:
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Episode 95:
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Episode 111:
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