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If you think the migration of trillions of dollars into passive investing strategies has put volatility to sleep, you're absolutely right – for the most part it has.
But what if blanket indexing isn't the dream investment it's cracked up to be?
What if the mad rush into passive investing vehicles merely casts a shadow over volatility?
What if passive investing is a black swan and it unleashes the volatility that crashes markets?
We're going to find out – maybe sooner than later.
Here's how passive investing masks real volatility and what to do to protect your investments from the inevitable return of volatility with a vengeance.
Passive Investing Is Indexing
Instead of trying to beat the market by being a stock picker, an increasing number of academics, Wall Street advisors, and product pushers are telling individual investors and some institutional clients that simply tracking the market by buying index funds is cheaper, less risky, and guarantees you won't do worse than the market.
Of course, there's no one measure of "the market."
The big three indexes everyone follows to determine what the "market" is doing are the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite.
Besides these there are plenty of others. There are indexes and averages that measure mid-cap market stocks, small-cap market stocks, sub-market indexes, industries, foreign markets, commodity markets, bond markets, and alternative market indexes.
And there are mutual fund and exchange-traded fund (ETF) products that track most of the indexes and averages investors might be interested in.
Buying an index fund, or diversifying by buying several different index funds, is what passive investing is all about. You're not an active stock picker, you're a passive investor if you're just buying the market, or markets, buying whatever funds track those indexes.
The passive investing trend is huge. And over the last few years, it's gotten too big for its own good.
This Trend Is NOT Your Friend
While passive investing's been around a long time (the first index mutual fund was launched by John Bogle's Vanguard Group in December 1975), a lot of money's been finding its way into the strategy since the financial crisis and the advent of hundreds of index ETF products.
Individual investors – many of whom became "self-directed" do-it-yourselfers – struggled through various market ups and downs. The 2008 financial crisis and market meltdown was the last straw for most, and they cottoned to the idea that being invested in the market, meaning buying the market, was the easiest and safest way to go.
With interest rates being manipulated so low for so long, the stock market became the place to earn yield and make money as the market appreciated.
And appreciate it did.
The market, whichever benchmark you choose, is up around 260% since March 2009.
As the market continued higher, it drew in more investors – not stock pickers, mind you, but passive investors who wanted in on the ride.
Macro Risk Advisors calculates that there's now $3.3 trillion held in passive investment vehicles, roughly split evenly between index mutual funds and ETFs.
And inflows are increasing. Almost $400 billion has flowed into passive investment products in the first half of 2017.
Those massive money flows, along with the bull market itself, have driven volatility to record lows.
Volatility always subsides – on the surface, at least – when markets are moving steadily higher.
But here's why I say "on the surface" and what's really happening that's so dangerous…
About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of 10X Trader, Shah presents his legion of subscribers with the chance to earn ten times their money on trade after trade.
Shah is also the proud founding editor of The Money Zone, where after eight years of development and 11 years of backtesting he has found the edge over stocks, giving his members the opportunity to rake in potential double, triple, or even quadruple-digit profits weekly with just a few quick steps.
Shah is a frequent guest on CNBC, Forbes, and Marketwatch, and you can catch him every week on Fox Business's "Varney & Co."
He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.