If you’re a passive investor, you better start getting your investments in shape today…

Passive investors buy securities designed to give the same returns as the market. They then hold them for years.

The goal is to duplicate long-term market performance by creating a portfolio that mimics the index it tracks. This can be done with a mix of funds and individual stocks.

If you pick the right securities (like those we own in our Palm Beach Legacy Portfolio), passive investing can be a good strategy.

U.S. stocks have returned over 9% a year for over a century. If you have a well-constructed portfolio, you’d likely beat that.

But if you’re not careful, this strategy could blow up in your face.

That’s especially true for passive investors who own index funds.

As we explained last week, some index funds own stocks that are too expensive… Or don’t otherwise fit the fund’s descriptions.

But that’s not the only reason passive investors should be wary of them… They’re overweight, too.

Here’s what we mean…

So much money has flowed into index funds that they’re now bloated. And that’s created an opportunity for active investors…

That’s why you need to grab your sweatpants and get off the couch. Active investments are poised to outrun the market as a whole…

Passive Funds Have Become Fat

Over the past 10 years, almost $1 trillion has flowed out of active investing funds and into passive investing funds. You can see the trend in the chart below.

That outflow has created huge market distortions.

Let me explain…

As we told you before, passive funds don’t care whether the stocks they buy are overvalued or undervalued. They just buy whatever is in their index.

This indiscriminate buying creates extra demand for all securities—even bad ones. And when demand increases, the price of the stock will go up regardless of fundamentals.

That’s making passive funds expensive and overweight. Now they’re ready for a crash diet.

Time to Cut the Fat From Your Fund

Active funds look for the best companies at the best prices. That requires them to continuously monitor their investments.

But active investing is hated right now. And that’s where our opportunity lies.

A study by PricewaterhouseCoopers forecasts passive investments will manage $22.7 trillion by 2020. That’s over a third of the global market.

Like we said, all this passive money is propping up the prices of bad companies.

Active funds are able to cut expensive stocks from their portfolios. Passive funds can’t… If they did, they’d no longer be “passive.”

If you’re a passive investor, now’s the time to trim some fat from your portfolio. You can do that by riding this cycle…

The Cycle We’re Watching…

All markets follow this cycle…

A trend becomes popular… Investors pile in… The securities get expensive… Then there’s a selloff.

And when the market sells off, active funds usually do better than passive ones.

Investment research firm Morningstar did a major study on active and passive investing. There was no clear winner between the two over the past 30 years.

But the study did find there were sustained periods when one type of investing outperformed the other (see chart below).

As you can see, passive investing performed better from 1995–2000… And again from 2010–2015. But for a 10-year stretch in the middle, active investing performed better.

Here’s the key takeaway…

When one form of investing gets too popular, the trend reverses. The unloved one eventually starts getting attention (and money inflows).

We think we’re entering another extended period when active will outperform passive.

If you’re a passive investor, you should review your funds. Then purge the expensive ones. If you still want to own a passive fund, take a look at some undervalued emerging-market indexes.

But if you really want to get your portfolio in shape, you should consider Chris Mayer’s Bonner Private Portfolio.

Chris has been Agora’s top-performing analyst over the past 15 years, averaging over 16% annual returns on safe, conservative value stocks. His stock-picking record is so impressive that longtime PBRG friend Bill Bonner is putting $5 million of his family trust’s money into his recommendations.


Nick Rokke, CFA
Analyst, The Palm Beach Daily

Recommended Link

Turn Off The Inauguration Coverage On Fox And CNN – Watch THIS Instead!
Over the years, Doug Casey’s forecasts have caused a lot of controversy… Like during the peak of the dot-com bubble when he warned a major crash in tech stocks was near… Or near 2008 when he warned America’s financial structure would be threatened with collapse. Critics called him “offensive,” “brash,” “irreverent.” But Doug was spot-on, every time. Not only that… Folks who heeded his warnings had the opportunity to make rare and extraordinary gains of 770%, 1,333%, and more. Yet, those could be a drop in the bucket if his latest controversial forecast about President Trump is right. If you want full details, you must click here.


It’s back…

After relatively stable prices in 2015, inflation is now climbing to over 2%.

The Federal Reserve tracks inflation via the Consumer Price Index (see chart below).

Now that inflation is above the Fed’s 2% target rate, it has the green light to continue raising interest rates.

If rates rise more, that will strengthen the U.S. dollar. And a stronger dollar is bad for U.S. multinationals… It will make their products more expensive overseas.

This is just another obstacle facing S&P 500 companies.

(Meanwhile, PBL editor Teeka Tiwari warns in today’s 3-Minute Market Minder that higher inflation could hammer long-term bondholders. Get the full scoop below.)

—Nick Rokke


This index is flashing gold

Inflation rates are starting to normalize… And PBL editor Teeka “Big T” Tiwari says that could be a tailwind for gold…

In today’s must-see 3-Minute Market Minder (transcript included), Big T says inflation has lifted gold almost $100 off its December lows. But if you’re holding bonds, you may want to look at your portfolio and consider taking this action


Populist Uprisings Rattling Markets: The rise of populism is threatening global markets. That’s the word from Ray Dalio. He’s the founder and co-chief investment officer at Bridgewater Associates. Dalio says “populism is the most important issue globally.” Of course, we’ve already been warning Daily readers about this trend.

Farewell, Welfare State: Only about half of 30-year-olds today earn more than their parents did at their age. In other words, this generation has made no financial progress compared to the previous one. And taking just men, the situation is worse… Out of 10 30-year-old men, only four earned more than their fathers in 2014. Longtime PBRG friend Bill Bonner says this trend signals that the welfare state is headed for bankruptcy.

Will a Robot Take Your Job?: Well, not yet. According to a new report, full automation threatens only about 5% of jobs globally. The report says that current technology could potentially automate 60 million U.S. jobs. But given the huge costs required for a mass transition to automation, the process wouldn’t affect all workers at once. So your job should be safe from robots, at least for now.

Pension funds are facing a combined $7 trillion shortfall. What are you doing to protect yourself from the looming crisis? Share your plans with the Palm Beach Community right here.

If you’re a passive investor, are you taking steps to become more active? Share what those steps are with the Palm Beach Community right here.


Legendary crisis investor Doug Casey just issued his shocking forecast for Donald Trump’s first 100 days… It’s a must-see after you watch his inauguration…