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Are passive investors missing a trick?

Popularity of passive funds has increased in recent years. But, are they the best option for investors in uncertain markets?

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Passive investing has long been hailed as a simple way of investing in the stock market. Instead of trying to outperform a particular stock market or index, passive funds or index trackers aim to closely track its performance, often by simply investing in every stock in the index they're tracking. This is in contrast to an actively-managed fund that will aim to beat the performance of an index.

Passive funds or index trackers can be a cheaper way to invest and diversify your money. And their popularity has soared in recent years.

In 2007, 15% of the total money invested across the EU was in passive funds. This grew to 30% in 2017. It's even higher in the UK, where passive funds make up about a third of investments.

But is it really the best option in today’s volatile markets?

When markets are doing well, the passive one-size-fits-all approach can offer a great long-term solution. During difficult times, passive investors can have a bumpier road than some active stock-picking counterparts.

This article isn’t personal advice. If you’re not sure if an investment is right for you please ask for advice. All investments rise and fall in value, so you could get back less than you invest.

Herd mentality can hit tracker funds harder

Most people know successful investing requires patience. But, the worry about suffering losses can cloud our judgement. Emotion can overpower rational decision making.

Not letting emotion cloud our judgement is tough - even for seasoned investors. For new investors, likely to be experiencing a falling market for the first time, it’s even harder.

Rash decisions to sell investments can exaggerate drops across the markets, which in turn, can spark more panic-selling.

When you invest in the whole market via a passive fund, you take part in all the wonderful highs and all the terrible lows, there's no shield. Many active funds on the other hand will be more selective about which companies they cherry-pick. Active fund managers will be doing their research and try to quickly make changes when needed. But there are no guarantees that they will succeed and active managers can under-perform the market if they make the wrong call.

Active managers plan for uncertainty

Over the past forty years, there have been a few major market crashes. These include Black Monday in 1987, the brutal popping of the dot-com bubble in 2000 and the 2008 financial crisis. Looking back at the recovery rates, it has been predicted that investors will need to wait between two to five years for the FTSE All Share to fully bounce back from today's coronavirus crash.

While nobody can predict the long-term impact coronavirus will have, active managers tend to plan ahead for periods of uncertainty. During volatile times, active managers have generally outperformed index funds. There's no guarantee this will happen in the future. Past performance isn't a guide to the future.

Stay balanced and think long-term

Whether you prefer to invest actively, passively or a blend of both, in our view it’s best not to make any rash decisions. It’s important to continue to keep your investments under regular review, making sure your choices continue to suit your circumstances and attitude to risk. Doing this regularly could put you in a better position for tough times ahead.

If you’re no longer happy with the balance of your portfolio, you could consider switching from investments which have done better into investments that haven’t done as well but in which you still have conviction. This can help even out your portfolio.

Hannah Duncan is an investment writer, and founder of Hannah Duncan Investment Content, with years of experience producing content for global leaders in finance and retail.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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