Warren Buffett does invest actively, but his advice to those who do not understand the capital market is passive investments that imitate the leading indices. By investing in a fund that mimics the S&P 500 index (Snoofy), for example, we can spread our investment over the 500 largest companies on the stock exchange in the United States, different and diverse companies from more than ten different sectors. In recent years you can see the rise of these funds, which are led by the largest investment house company in the world
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. At the end of 2021, the company managed over 10 trillion dollars, more than 20 times the state budget for that year. The company recorded incredible growth when only in 2014 the volume of assets it managed was 4.6 trillion dollars and it is clear then what the direction of the trend was in terms of investors in recent years when it comes to passive investment.
What actually leads the trend of passive funds?
The most significant thing about passive investing is that over time, the vast majority of active funds fail to generate a higher return than the index, although in some years some and even most investment houses manage to do so (as in 2021), but this success does not last long and prevents from us to enjoy the effect of interest de interest. An investment manager of a certain active fund needs to generate as high a return as possible for the investors in the fund, otherwise they will leave it and in order to do this he needs to analyze the market situation and try to identify which investments will work in the near future and which will not. Part of the way the manager works is (assuming we’re talking about a fund that only invests in stocks), to buy stocks that he thinks will go up in price soon and, in contrast, sell those he holds and expects their price to drop – something that is usually very difficult to do, of course over time.
When a fund manager determines that a certain stock is going to fall or, alternatively, that it has fallen too much and he decides to sell it to cover the losses, he actually loses the profit potential of the stock at a discount and it will rise. If a fund manager had bought the shares of Apple in 2007 and held them until today, he would have made a return of more than 50 times on his money, the problem is that since that point in time the stock has experienced many declines, some of them too substantial for him to hold the company, and he actually loses the profit potential. A passive fund will not sell the shares in the index, unless it has changed, which leaves those who are willing to withstand the declines of the stock market over time, to enjoy a greater downside.
In addition to the broad diversification that can be obtained through the passive funds, we can choose specific sectors in which we wish to invest, even though we actually must be familiar with the field or the companies in it. If, for example, I believe that real estate in Israel will continue to rise in the coming years and I predict that the future is rosy for companies in the sector, I can buy a fund that mimics the activity of the index – which contains real estate companies of any kind, without having to understand each and every company and I can enjoy The growth of the sector even if a certain part of it performs less well.
Another matter, no less important for many investors (especially for the long term), is that the management fees in the passive funds are significantly lower than the active ones, since there is no need to analyze one or the other for the state of the market or which stocks will do well in a certain period of time. The fund manager should not be under pressure to provide as much and higher return as possible, since this is not the goal of the fund, the goal is to provide the same return as the index/shares the fund follows.
What then is the problem inherent in the idea of passive investment in the index?
When investors purchase a passive fund that follows an index, for example the Snoopy, they flow money to an investment house that manages the fund and with the help of those funds, it invests in the same stocks that make up the index. When many investors buy these funds, the value of the shares in the same indexes also increases and in a non-differential way – if the value of Snoopy for the purpose of the example is $10 trillion, and in one year investors purchased a fund that imitates the index in the amount of $5 trillion, the entire index will increase by 50% The problem with this is that the situation creates an image that does not necessarily reflect reality, of the 500 companies in the index, some are better and some are less so, and it is clear that there is no reason why the value of will increase (if at all) this year to the same extent.
Another matter, which continues the previous one, is that when much of the money invested in these funds is in “weak hands” – investors who are not ready to withstand large declines, declines due to events in a single company that is at the top of the index such as Apple, may cause them to sell part or the Most of their investment in the index. When many investors do this, a snowball is created just because a single share went down (which could very well be true) – the stock will go down because of a certain event that happened in the company (whether under its control or not), investors will sell some of the funds they hold, the other shares in the market will also go down Even though nothing problematic happened to them and in fact the whole market goes down and causes even investors with “strong hands” or those who were leveraged on some of the shares to sell and pull the market down even more.
One of the most famous investors in the world – Michael Berry, who predicted the crisis in 2008, claimed himself about 3 years ago that the market of passive funds can pose a danger to the markets. According to him, the market for these funds creates a bubble, which when it bursts, will harm the entire market and all investors.
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