Why The Rise of Passive Investing Might Be Distorting The Market

Tracy Alloway (0:10)

Hello, and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

Joe Weisenthal (0:15)

And I'm Joe Weisenthal.

Tracy Alloway (0:17)

So Joe, I tweeted something recently, and it provoked a large response on social media. It's weird how that happens, right?

Joe Weisenthal (0:27)

You tweeted something that provoked a response? I find it very hard to believe.

Tracy Alloway (0:31)

I know, it's outrageous. But I was talking about, have you heard of the fire movement?

Joe Weisenthal (0:40)

Vaguely, like I am familiar with it. It has to do with people retiring early, right?

Tracy Alloway (0:47)

Yeah. So it's FIRE as in F-I-R-E, and it stands for Financial Independence Retire Early. And the basic idea is you can save a lot of money, and if you invest it wisely, you can retire at an early age, like in your 30s. And supposedly, it can work out for even normal people or people on normal salaries. We're not talking about really wealthy people.

And the thing that I always find really interesting about it is when you go and read about how people are actually investing that money so that they can retire early, they're almost all talking about doing it A, themselves, and B, through passive investments like ETFs.

Joe Weisenthal (1:32)

Right. Exactly right. So people think, okay, they live frugally.

They work for several years, they live frugally, but then they sort of have this confidence that historical returns that we've seen in stock and bond markets throughout the world will just always be there for them in the future. And so they just put a bunch of money in passive ETFs, or passive-ish ETFs, and then they count on that existing for the rest of their lives. And then they do something, I don't know, they go on Reddit or tweet for the next, like from 35 until they die.

Tracy Alloway (2:03)

That's right. And the reason I find this, you know-

Joe Weisenthal (2:06)

Which doesn't sound bad to me, to be honest. I would be fine, I would do that if I had confidence-

Tracy Alloway (2:11)

You can see the allure-

Joe Weisenthal (2:12)

That the market would just keep going up.

Tracy Alloway (2:13)

For sure. But the reason I find it so interesting from a market perspective is to me, it hits upon like a number of very, very important themes, but really it hits upon this question of whether or not the fire movement can exist without the bull market that we've seen for the last 10 years, right? Like it's very easy to say dump all your money in something like a Vanguard total stock market ETF and just watch it soar when that's the thing that's been happening for years and years and years.

Joe Weisenthal (2:48)

Well, I'll say two things. So one is it certainly raises the question about whether this subculture can continue to exist, but it also raises another question about people who aren't in that subculture, but in a way have de facto bought into it because this mantra that we've gotten from sort of the media and the fund management industry is, okay, most people aren't saying you should try to retire at 35 or 40, but this idea, never try to time the market, never pick individual stocks, just have a broad diversified basket of ETFs that you maybe rebalance every once in a while has become so intense and extreme, and everyone's being pushed to invest like that. So even if you are one of the fire people on Reddit, it still raises the question of how much has everyone else who is not planning on per se retiring early essentially bought into a less extreme version of the same story.

Tracy Alloway (3:42)

Absolutely. And you'll see a lot of the investment advice that the fire people talk about is actually very, very similar to advice given to people generally when it comes to their 401Ks and stuff like that. Passive is supposed to be cheaper, it's supposed to be much better. But what if there's a downside to passive investing? We've spoken about active versus passive on the podcast before, but we haven't done that much on how passive investing might actually be changing the way the market functions.

Joe Weisenthal (4:12)

No, absolutely. And it's such an important question given as we've been talking about how many people have portfolios in which the only action they do is just add to the same basket of three or four ETFs every single month for their working lives. It's been fantastic since the crisis with the incredible rally in stocks and bonds simultaneously.

But as they say, past performance, no guarantee of future returns.