Passive investing's champion and biggest cheerleader over the years, Jack Bogle, founder and retired CEO of The Vanguard Group, has changed his tune.
Don't get me wrong - he still believes that being in "the market" over the long haul is still the best way to build wealth.
But he's worried about the effect ETFs are having on the stock market. While we think Bogle is onto something here, it gets even worse for passive investors, too...
Bogle sounded the alarm in a recent Wall Street Journal article, saying that the top three passive funds are nearing effective control of U.S. stocks. In short, the popularity of passive investing is making the top ETFs the largest shareholders of many public corporations.
Such concentration of stock ownership is not good for the industry or even the nation. Bogle concludes that "a handful of giant institutional investors will one day hold voting control of virtually every large U.S. corporation."
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Think about that. Ownership of most of corporate America in the hands of a few big institutions.
Why is that bad? An oligarchy - a small group of people having control of a country, organization, or institution - does not allow for a truly free market. And those who control the production of goods and services can control the destiny of the country. You can see where this can go.
Bogle offers a number of fair-minded solutions to diluting the influence of ETFs on corporate governance.
But there's another danger lurking behind ETFs, one that could put a serious dent in your retirement plans if you're not careful.
That's especially true during sell-offs or bear markets...
Why Passive Investing Isn't All It's Cracked Up to Be
Passive investing offers investors average market returns. And when the market starts to take a beating, like what happened in December, passive investors lose too.
Investors need to do some work to understand when the market offers truly great value and when it is just too risky.
Wall Street loves to travel in herds, and their collective mantra of buying and holding a low-cost index or ETF smacks of complacency. But resigning yourself to average returns, even negative returns like the 10% haircut the market took in December, isn't going to get you to your retirement goal. That's especially true when everyone else is following the herd.
Money Morning Special Situations Strategist Tim Melvin sees the fatal flaw to this strategy.
Tim says too many investors believe passive investing is "safe." All they need to do is buy and hold, and they'll come out on top.
This just isn't true.
Depending on when you buy in, you could get pummeled, despite what looks to be a sound investment philosophy. Those investors who bought in during the late stages of the 1990s bull market look at life a bit differently than those who bought in the early stages of the 2008 financial crisis.
Think about it. The Dow is up just 116% since June 1999. But it's up 231% since March 2009. When you buy makes a huge difference for your returns.
And the reality is that over the past 20 years, the market only offered a 4% annual return. While there were three huge bull markets in that time, there were two brutal bear markets where prices got cut in half.
When you bought into your "safe" Dow Jones ETF decided whether you made money or barely broke even.
But active investors can control not only when they enter or exit a certain investment, but precisely which investment they are going to make...
How the Rich Get That Way
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The wealthiest investors do not make regular contributions to their ETF accounts with payroll deductions. They wait until the market presents high-quality companies at bargain bin prices, and they buy them to hold for a long, long time.
Do you think Warren Buffett is worried about the $85 billion his holdings in Apple Inc. (NYSE: AAPL) have lost since the middle of last year? Not a chance. He did not buy it because of how it might perform in any one quarter. He bought it with a time horizon of 10 to 20 years, and so as long as it is a leader and has great management and a sustainable business model, he's in.
That's how his company, Berkshire Hathaway Inc. (NYSE: BRK.B), demolished passive investors' returns. While a passive investor who bought the market in June 1999 barely doubled their money over the last 20-year period, Buffett quadrupled his shareholders by knowing not just when to buy and sell, but what to buy and sell.
And that's the difference between the retirement of your dreams and staying in the workforce another five years.
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