Last year we asked if you were an active or passive investor. As the stock market approaches or perhaps has reached a turning point is there a problem with passive investing in index funds that track the S&P 500?
As the stock market rally grows older the time will come when the high tech and large cap stocks that are leading will have problems. Then passive investors who simply put money in a fund that tracks the S&P 500 will be in trouble.
Solid fundamental analysis will tell today’s investor to diversify his or her portfolio and look for investments like consumer stocks that will more easily weather the storm of a market meltdown. But if you are a passive investor and you money is in an index fund that tracks the S&P 500 are there too many high tech stocks in the S&P 500 and that will spell trouble when the market turns? CNBC writes that the high concentration of tech stocks is a danger sign.
“The excesses of this bull market are in the glam techs,” Smead said on CNBC’s “Closing Bell,” referring to names like Amazon, Tesla and Netflix.
Currently, 25 percent of the S&P 500 is composed of tech stocks and large cap stocks like Amazon and Netflix. His investment firm, based in Seattle, is the owner of long-duration common stocks.
“It was a danger signal for RCA stock in 1929, the Nifty Fifty stocks in the 1960s, oils in 1981, tech stocks in 1999 and banks in 2005,” he said.
Smead argued that in each era, the large concentration of stock in a particular sector helped propel the bull market, but was followed by a crash made significantly worse because of the losses.
Those who buy into this argument may wish to rebalance their portfolio. Investopedia writes about how to do this.
Rebalancing is the process of buying and selling portions of your portfolio in order to set the weight of each asset class back to its original state. In addition, if an investor’s investment strategy or tolerance for risk has changed, she can use rebalancing to readjust the weightings of each security or asset class in the portfolio to fulfill a newly devised asset allocation.
The asset mix originally created by an investor inevitably changes as a result of differing returns among various securities and asset classes. As a result, the percentage that you’ve allocated to different asset classes will change.
The point of doing this in today’s market is to reduce your risk as the market softens and the risk of a large correction or crash looms. If you want to continue passive investing you may wish to pick another index fund that is not so top-heavy with tech to balance the current S&P 500 or you may wish to pick a handful of consumer, utility or other non-tech stocks as the counterweight to balance your investments. At the current time the problem with holding cash is that the dollar is falling in relation to other currencies and the interest rate is likely to rise which will reduce the value of any bond that you buy.