A Podcast Recommendation

One of the podcasts I like is the Rational Reminder: "Sensible investing and financial decision-making, from two Canadians".

It provides great insight into personal finance, and a recent episode is well worth listening to if you are an index investor.

My views on low-cost investing are best summed up in my blog post from 14th January 2021, "Do less and make more". The inspiration for that post came from the late Jack Bogle's book "The Little Book of Common Sense Investing." In summary:

1. Low-cost investing is essential to maximise returns over the long term.

2. Index investing, as advocated by John C. Bogle, is a simple and effective strategy accessible to everyone.

3. Outperforming the market consistently is nearly impossible, and low-cost index funds have a high probability of beating actively managed funds over the long run.

4. Behavioural biases, such as buying high and selling low, can negatively impact investor returns.

5. Asset allocation dictates investment performance and lower investment costs allow for taking less risk to achieve the same level of return.

If this is something that you believe too, I suggest listening to the Rational Reminder 25th April episode (302) with Michael Green, a well-thought-through discussion about the impact of market liquidity on investment strategies. In summary:

1. He argues that the growth of passive index investing has made markets less elastic and more fragile. As more money flows into index funds that buy stocks regardless of valuations, it pushes prices higher in a feedback loop. But this also means prices could fall drastically if there are ever large outflows.

2. This dynamic makes it harder for active managers to outperform passive funds over time.

3. He sees major risks building; he notes the solution is very difficult politically since the index fund narrative is so entrenched.

4. Paradoxically, investors should keep investing in index funds individually, but collectively it creates growing fragility.

5. Regulators and the biggest fund providers can address this, but they are currently incentivised not to. It may take a very severe event to force changes.

What are the main differences between Bogle and Green?

Mike Green's perspective on the growth of passive investing differs from Jack Bogle's in several key ways:

1. Market impact: Bogle believed that passive investing was a net positive for markets and investors, making investing more accessible and lowering costs. Green argues that the growth of passive investing is making markets less efficient and more fragile.

2. Price discovery: Bogle believed that as long as there are some active managers in the market, prices will be set efficiently. Green suggests that the proportion of active managers is becoming too small to effectively counteract the impact of passive flows.

3. Systemic risk: Bogle didn't see passive investing as a source of systemic risk. Green argues that the growth of passive investing is creating a feedback loop that amplifies market movements and could lead to a severe crash if outflows accelerate.

4. Active management: Bogle believed that active management was largely a losing proposition for investors due to higher costs and the difficulty of consistently outperforming the market. Green suggests that active management is becoming structurally disadvantaged due to the distorting impact of passive flows, rather than just being a matter of skill.

5. Future returns: Bogle believed that passive investing would continue to deliver satisfactory returns for investors over the long term. Green is more sceptical, suggesting that a significant portion of recent market gains may be attributed to the shift towards passive rather than fundamental factors.

In essence, while Bogle saw passive investing as a largely benign and beneficial trend for investors, Green sees it as a source of growing systemic risk that is fundamentally altering the way markets function.

However, both seem to agree that for most individual investors, passive investing remains the most practical and rational approach, even if their reasons for this conclusion differ.

You may, however, want to consider what a drawdown of 85% would do to your portfolio and frame your risk appetite with this in mind.

This is why I like the Rational Reminder; some really good insights into personal finance presented by two knowledgeable and thought-provoking Canadians.