Why Money Is Pouring Into Passive Investments

Posted on August 29, 2014 at 10:33 AM PST by

The Wall Street Journal recently covered an interesting trend in investing: People are trying hard to not do it anymore.

Which is not to say they aren’t trying to save or put their money to work. They’re just trying hard not to pick stocks or otherwise attempt to beat the market.

Vanguard Group, the grandfather of the growing index fund universe, now manages an astounding $3 trillion in assets. As of the first quarter of 2014, there was $23 trillion in retirement assets total, according to mutual fund industry group the Investment Company Institute.

passive investments

That’s counting everything there is — annuities, government pensions, private plans and individual retirement accounts. Put another way, Vanguard alone manages half of the amount as there is in all “defined contribution” plans totaled, a broad way of saying workplace 401(k) and 403(b) plans.

It’s a lot of money, and it’s pretty much all invested. Unlike stock pickers, Vanguard doesn’t sit on much cash, waiting for an opportunity to buy in. Mostly, it owns investments, collects dividends and interest and in many products rebalances along the way.

We’re big fans of the Vanguard approach. We also believe that investors are better served by staying in markets, by keeping costs very low and by rebalancing judiciously.

But don’t take it from us. As the Wall Street Journal noted in the same article, Warren Buffett, the billionaire investor, told holders of his Berkshire Hathaway shares that he intends to tell his heirs to just buy index funds and forget about playing the market.

To quote him directly “put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.).”

This is where, respectfully and with great humility, we part ways with Buffett and even Vanguard. Keeping costs low is a huge factor, of course, but only a young investor should consider a static stock-bond mix of 90/10 and leave it at that.

Steady gains

As we’re sure both Vanguard and Buffett would agree, the best way forward for retirement investors to take into account one’s own time horizon, that is, how many years until you need the money you have saved.

From there, the research shows one should own a mix of investment types that tend to move in opposite directions — when one goes up, the other often goes down. That provides an opportunity to sell high and buy low, capturing gains steadily along the way.

It’s by using the tremendous advantages of low-cost investing through index funds, along with the upside that comes with smart rebalancing, that long-term investors find the steady gains they need to compound their savings into wealth.

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