This Day On The Street
Continue to site right-arrow
This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

Take a Pass on Passive Index Investing

Stocks in this article: GWX DFFVX

I just don't understand the attraction to passive investing. The idea is simple enough; use only broad-based index funds and always stay fully invested (save for rebalancing to the target allocation). The proponents of passive investing believe that active management cannot reliably beat the market and they have plenty of data to back up the theory.

An article I read the other night about this investing style got me thinking. The chart below features all of the funds mentioned in the article, showing their performance year to date. I don't think the names matter a whole lot. It could just as easily be a completely different set of index funds, but the result would likely be very similar.

This has been a very aggressive bear market, with just about every stock or fund down a lot. The best-performing fund of those charted below is the DFA US Targeted Value Portfolio (DFFVX), which is down 30% year to date. The worst-performing fund of the group thus far is the SPDR S&P International Small Cap ETF (GWX), down almost 50% this year.

The article in question did not give weightings of each fund in the portfolio, but it is reasonable to assume the portfolio is down 35%-40% year to date and close to 45% since the peak in the S&P 500 on Oct. 9, 2007.

As mentioned above, the passive indexers have the data on their side, so I will not win any debates; but how comfortable are you with your account dropping 40% and doing nothing to try to avoid a decline of that magnitude?

The Bear Market Pull
Index funds followed a downtrend this year
Click here for larger image.
Source: Yahoo! Finance

It may be difficult to remember, but the stock market goes up most of the time (72% of the time the stock market has an up year), and so it is reasonable to assume most active managers will lag. However, I'm advocating not for active portfolio management so much as for trying to not go down 40%.

I believe one way to assess the stock market is by looking at the health of demand for equities. When demand is healthy, be fully invested; when demand is not healthy, take some sort of defensive action with your portfolio.

"Some sort of defensive action" would mean different things to different people. Some may want to go 100% cash or sell half or ease out slowly. No path is guaranteed to be 100% correct, but some sort of defensive action when demand for stocks first cracks can help avoid a lot of pain.

1 of 2

Check Out Our Best Services for Investors

Action Alerts PLUS

Jim Cramer and Stephanie Link reveal their investment tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
Quant Ratings

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
Stocks Under $10

Jim Cramer's protégé, David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
Try it NOW
Try it NOW
Try it NOW

Check Out Our Best Services for Investors

Dividend Stock Advisor

Jim Cramer's protégé, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Updates with exact steps to take - BUY, HOLD, SELL
Trifecta Stocks

Every recommendation goes through 3 layers of intense scrutiny—quantitative, fundamental and technical analysis—to maximize profit potential and minimize risk.

Product Features:
  • Model Portfolio
  • Intra Day Trade alerts
  • Access to Quant Ratings
Options Profits

Our options trading pros provide over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • Actionable options commentary and news
  • Real-time trading community
Try it NOW
Try it NOW
Try it NOW
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!


DOW 17,164.95 -251.90 -1.45%
S&P 500 1,994.99 -26.26 -1.30%
NASDAQ 4,635.24 -48.1670 -1.03%

Partners Compare Online Brokers

Free Reports

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters
Top Rated Stocks Top Rated Funds Top Rated ETFs