So passive investors are mostly locked into a tax wrapper. So they keep buying, with the hope of withdrawing at some point in time. More on the sequence of returns risk, later.
But, they are actually going against two major factors that generate stock returns - Size and Valuation.
Since a vast majority of passive investors use market cap weighted index tracker funds (go look at your brokerage statement; you are no different!), when momentum increases stock prices, they often buy the largest, most expensive stock, at the peak. This is your usual ‘bull year’, my investments are growing case. And their banks, and brokerages are going to tell them, that markets are volatile, so stay invested.Even if they wanted to, they can’t exit so easily. They will face all the brakes and speed humps when they try. Good for us, stock pickers, and fund managers, you see.
If we just snip out the most overvalued, mega cap stocks, the rest of the index stocks, gives us an opportunity to beat the market. In the case of the S&P 500, snip out the magnificient seven tech stocks. They take 35% of the index anyways. The remaining stocks are still fairly valued. Pick five, or ten, and build a portfolio. That beats the market by breakfast tomorrow.
Easy peasy investing! But a smarty pants way. What do you think?
