Pretty fly for a white lie

Fire up your favorite search engine and search for “index funds”. You’ll hardly hear anything bad about them.

All the experts agree: passive investing is better than active investing.

This is not only stoopid but, on some level, I have to believe the professionals are being intellectually dishonest about promoting this idea.

Passive investing is like passive secks… IT DOESN’T EXIST (not even for frustrated and confused Mormon BYU students).

It’s Obvious as Adams for those with eyes to hear and ears to see… buying and selling stocks, mutual funds, or ETFs and… even dividend-paying whole life insurance… is an ACTIVE endeavor.

WHEN you buy (and/or sell) these things (and for life insurance, WHO you buy from, WHICH companies you choose to own, and WHEN you take on policy loans) determines whether you’re good at it or not.

It doesn’t matter if you hold onto these things for 20 years or 2 days. Money is never passive. Or… maybe I should rephrase it like this: when money is passive, it means you’re earning ZIP on it. Nothing. Nada. Delete-O Dinero.

Now… that doesn’t mean peoples’ attitudes toward their money can’t be passive. Clearly they are and this is why so much munnay is flowing into index funds.

Oh, but here come the critics: “Then why am I making so many returns on my munnies invested in index funds Dave-O?”

The answer is simple and obvious: supply and demand.

The little “white lie”, called passive investing, has attracted many monies over the last 17 consecutive years… index funds now own more than 40% of all U.S. stocks. If you look at the demand, a lot of the increase in asset prices is due to constant inflow of monies.

I mean seriously. Graph it on a vertical bar chart. The growth has been so consistent that the chart looks like a set of stairs safe enough for a clumsy crawling toddler.

At the current growth rate, index funds would own the entire market by 2030.

But… that can never happen because then there will literally be no one buying and selling stocks to create the prices that index funds rely on.

See… normally what happens is you have traders buying and selling stocks in the index and that’s what sets the price of the stock.

Someone wants to buy some shares of a company’s stock and makes and offer. Another person wants to sell their shares and makes a counteroffer. Eventually they come to some sort of agreement on the buy/sell price and THAT’S the price of the stock.

It’s like a great big auction house.

There’s no mandate for any investor to buy any given stock. They just wander into the marketplace and find a company they think is profitable and they buy shares in that company.

But… an index fund does something completely different.

It has NO choice but to buy stocks when they are added to an index (e.g. the S&P500) and sell stocks that are removed from the index.

Very mechanical.

And pretty much every major market index is capitalization-weighted. Meaning, larger companies have more influence in the market than smaller companies.

Well, an index fund must automatically allocate capital (money) to match the index weighting… it has no choice. That is its reason for existing. To match the index.

And this means allocating capital according to the SIZE of the company but not the QUALITY of the company. In other words, index funds are explicitly NOT buying stocks in the index because of any profit goals. They’re buying stocks BECAUSE they’re in the index.

That’s it.

That’s the only reason they’re buying them.

It is probably the single dumbest investment strategy ever invented.

Ever.

Because… it almost guarantees that capital gets misallocated.

Large, mismanaged, companies can see their stock price get bid up as index funds are forced to buy their shares and smaller, but more profitable, companies can see their stock price languish because they don’t get enough weighting in the index.

Indices were not invented as a guide to investing or as a measure of good vs bad companies or as a guide to which companies are more or less deserving of capital resources.

They were invented simply to measure and track the growth of the companies included in that index and (later on) serve as a proxy for the general health of the country’s economy.

But index funds undo this process because of their stoopid buying strategy.

Anyway… the more money that flows into index funds… the more capital is misallocated until…

BOOM.

And this is why indexing will never win.

Because smart active investors will find profit opportunities (e.g. shorting opportunities, “front-running” opportunities, etc.) created by that misallocation of capital and bring down the passive investing house of cards.

And the free ride will be over.

Finito.

Then, all those passive investors can dump whatever remains of their moolah into the new “passive” investing strategy: roboadvisors… and the process can start all over again.

OK, rant over.

On to bid’niz.

I design and sell custom whole life insurance. But, it’s almost never a “one and done” affair.

I encourage my clients to use their cash values to go out and find opportunities whether it’s paying off debt or investing in something they know about.

If you’re a passive-type investor, or just passive-minded, you’ll be very disappointed and frustrated by the way I do things.

However…

If you’re an active-minded person and you want to better manage your cash flow and investments, then hop on my email list and I’ll show you how it’s done.

David Lewis

This post brought to you by //The Rogue Agent//. David has been a life insurance agent, and worked with some of the oldest and most respected mutual life insurance companies in the U.S., since 2004. Learn more about him and his business, here.