QuickTake: The Downside of Passive Investing

Do you have a major cash outlay looming?   Do you want to stay invested in stocks but are concerned that, in the meantime, a large market drop will leave you with insufficient assets?  If so, passive investing may not be for you.   That's because passive investing mimics the ups-and-downs of a market index such as the S&P 500.  It provides no downside protection.  Instead, you might want to invest in a more defensive actively-managed portfolio.   This QuickTake offers some thoughts on the issue.

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Transcript

Speaker 1: 0:26

Hello, I'm Clem Miller. Welcome to Skeptics Guide to Investing. Today I'm doing a quick take on the downside of passive investing. This quick take is pertinent to those of you who are concerned about losing your investment money and are willing to forego some upside return in exchange for some downside protection. Are you somebody who wants to stay invested in the stock market but is concerned about losing money ahead of a big personal cash outlay? If so, this quick take is for you.

Speaker 1: 1:01

So let's define passive investing. A passive investment product is any product that purports to mimic the ups and downs of a market index, such as the S&P 500. By definition, a passive investment product offers no downside protection. It follows the ups and downs of the index automatically. To achieve downside protection, you need an actively managed investment product that is heavily weighted towards three defensive sectors healthcare, consumer staples and utilities.

Speaker 1: 1:40

You see lower weights to Magnificent 7 and other technology stocks in defensive portfolios. As a result, defensive portfolios have recently had less upside than have passive investment products. However, defensive portfolios are better protected in a scenario where some share prices for the Magnificent 7 and other technology stocks start to collapse. Of course, many folks look at the lofty valuations of Magnificent 7 and other technology stocks and wonder when and not if, those share prices will fall. So, summarizing, if you have potentially big cash outlays in the near future, you may want to invest in an actively managed defensive stock portfolio, not a passively managed product that simply mimics the ups and downs of the market. Thanks for listening to this quick take. Stay tuned for more content from Skeptics Guide to Investing.