Passive investing in volatile markets: experts weigh in

Investors often hear that despite market crashes, stocks tend to go up over time. But tell that to investors watching their portfolios decline, especially if they invest passively in index funds. Those represent groups of stocks which track indices like S&P; 500 (^GSPC), Nasdaq (^IXIC), or the Dow Jones Industrial Average (^DJI).

In continuation of Yahoo Finance’s series ‘What to do in a bear market,’ we asked the experts what they think of index investing during these volatile times.

The markets have taken a beating this year. Passive investors in index funds are under water. Is index investing over?

“Broadly speaking it’s not a good idea to try to time the market, whether you’re buying an index fund or an actively managed fund. When the market goes down it’s often the best time to be putting money to work for the long term. For the past decade plus we were in a period of cheap money where fundamentals were less important,” Jim Polk, head of equity investments at Homestead Advisers, told Yahoo Finance.

“Almost all stocks were going up so being in an index was fine. The more assets that flowed into an index fund the more the fund had to buy what they already owned, which created a virtuous circle,” he added.

Meanwhile Terry Sandven, chief equity strategist at U.S. Bank Wealth Management said, “History shows investors with long time horizons tend to experience favorable returns as the year-to-year gyrations of returns, both positive and negative, get smoothed out of the longer time period. This applies to both active and passive investment styles.”

Do investors have to be more choosy when investing?

“Investors should always be choosy when investing, though in a climate of high uncertainty and lower expected returns, doing so becomes even more important,” Daniel Berkowitz, senior investment officer at Prudent Management Associates, told Yahoo Finance.

With rising interest rates, “We think the investing environment will be more difficult than it has been in the past few years. The market will differentiate between companies and stocks much more than in the past few years,”said Polk of Homestead Advisors.

“As active managers we believe there’s value to knowing what you own and applying a disciplined process to identify high-conviction opportunities. And with this changing market dynamic more value will be placed on active managers who can differentiate themselves from the benchmark,” he added.

How do investors look for and choose winning assets?

“Not all stocks are positioned equally. ‘Winner’ stocks are those that best align with investor objectives, ranging from international versus domestic, large versus small companies, growth versus value styles, and asset allocation mix,” Terry Sandven, U.S. Bank Wealth Management chief equity strategist, told Yahoo Finance.

“Ultimately, companies need to generate consistent revenue growth to trend meaningfully higher. Other factors include balance sheet strength, capital requirements, cash flow, competitive landscape, etc,” added Sandven.

For investors using actively managed strategies in particular, “holding them through full market cycles is critical to success. Identifying winning managers in advance is challenging, but it’s only half the battle,” said Berkowitz of Prudent Management Associates.

“It is very easy to bail on an actively managed strategy that is significantly underperforming the market in a given year, or even a 3-year horizon, but even the most successful active strategies experience this type of underperformance—it’s a natural part of investing,” he said.

Ines is a markets reporter covering stocks from the floor of the New York Stock Exchange. Follow her on Twitter at @ines_ferre

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