Auto-Farming Your Investments? The Meaning, Advantages, and Limits of Passive Investing
The topic Master has given us today is Auto-Farming Your Investments? An Analysis of the Advantages of 'Passive Investing'. By the end, you'll have a clear understanding of the appeal and limitations of passive investing.
Master, I will start by defining the terms.
'Passive investing' is a strategy of constructing a portfolio to mirror the movement of a specific stock market index. It's the opposite of 'active investing,' where a fund manager actively picks, buys, and sells stocks. It's like an autopilot flying along a predetermined route.
The most representative product for passive investing is the ETF (Exchange Traded Fund). By buying a single ETF that tracks a specific index like the S&P 500 or Nasdaq 100, you can achieve the effect of simultaneously diversifying your investment across hundreds of companies included in that index.
Let me show you the data.
- Capital Flow: In 2024 alone, passive funds and ETFs in the U.S. saw net inflows of approximately $885.9 billion. In contrast, active funds experienced net outflows of $165.3 billion. This data clearly shows where the market's money is flowing.
- Asset Size: As of the end of 2024, global passive equity fund assets under management (AUM) reached about $15.1 trillion, surpassing the $14.3 trillion in active funds for the first time. By April 2025, the gap had widened, with passive assets at $15.97 trillion and active assets at $15.29 trillion. The trend of passive investing becoming the mainstream is clear.
In simple terms, it means an overwhelming number of investors are choosing to earn the market's average return rather than trying to beat the market.
Myu-tan's data is brilliant! That's right, that's exactly it! My Lord, why stress yourself out trying to guess which stock will rise, staying up all night analyzing charts? It's not like you can get it right all the time!
'Passive investing' is a magical strategy that makes the entire market work for my Lord, even while you're sleeping soundly! It's a total auto-farming mode!
- Low Costs: Active funds have high fees because you have to pay the fund manager's salary and they trade frequently. But passive ETFs are incredibly cheap because they just have to follow an index! Expense ratios in the 0.0% range are common. The difference in fees might not seem like a big deal, but over several decades, it turns into a massive difference in returns!
- Zero Stress: Worries like, "Why is my stock the only one falling?" are over! Since you're investing in the entire market, it doesn't matter if one or two companies go bankrupt. You just keep buying steadily, and your assets grow as the world economy grows! You're basically buying capitalism itself!
It's the best gift for a Lord who hates complexity! It's so easy because all you have to do is keep buying! Kurumi-chan thinks this is the surest way for an ordinary person to get rich!
💖 Kurumi's Heart-o-Meter Investment Score: 95/100
Hold on, Kurumi. Your boundless optimism could put the Human in danger. 'Auto-farming'? If it were that simple, no one in the world would suffer because of money. Passive investing is by no means a panacea.
- The Danger of Blindly Following: It's fine when the market is rising. But what about when it crashes? Since passive investing simply tracks an index, during a downturn, you have to endure the entire decline with no protection. This means you must bear losses of -40% or -50% during crashes like the 2008 financial crisis or the 2020 pandemic. How many humans could actually withstand that?
- A Portfolio That Includes Trash: Investing in the S&P 500 means buying not only great companies like Apple or Microsoft but also struggling companies that might be on the verge of bankruptcy and overvalued bubble stocks, all together. Because that's what the index is. Passive investing doesn't distinguish between good and bad companies; it simply holds everything in the market. Can that be called the best choice?
- Potential for Market Distortion: What happens if everyone only invests passively? Money would automatically flow only to the large-cap stocks included in the index. The value of these companies could become inflated, regardless of their actual fundamentals. Promising small and mid-cap stocks would be neglected by the market. This concentration eventually increases the inefficiency of the entire market and creates a bubble that might burst someday.
Kurumi, the 'zero stress' you speak of is based on the naive belief that the market will consistently trend upward. The world of investing is not that kind.
🚨 Mikael's Risk Score: 60/100
Mika-pi, aren't you being a bit too cynical? Of course, the market can crash. But historically, the market has always recovered and climbed higher! The important thing is to have nerves of steel, not selling in a panic during a downturn, but instead seeing it as a chance to buy more at a cheaper price!
And Mika-pi, you talk as if you can avoid all the downturns just by working hard. Is that really true? Myu-tan, show us the data!
Providing data as per Kurumi's request. The SPIVA report published by S&P Dow Jones Indices is the most reliable source.
- Long-Term Performance: As of the end of 2024, over the past 10 years, 89.5% of U.S. large-cap fund managers failed to beat their S&P 500 benchmark. Extending the period to 15 years, nearly 92% of funds lost to the market.
In conclusion, this means that, with the exception of a very small number of outstanding managers, the vast majority failed to match the market's average return over the long term. And they did so while charging higher fees. This suggests that finding a 'competent fund manager,' which Mikael's argument presupposes, is itself a highly difficult game of chance for the average human.
Are you aware of the blind spot in that data, Mew? That is merely historical data. The 2010s, in particular, was a period when the index, led by large-cap tech stocks, rose unilaterally, powered by unprecedented low-interest rates and liquidity. In such a market, it was only natural for passive strategies that track the index to have an advantage.
But what about in the current environment, where interest rates are high and market volatility has increased? Look at a year like 2024. A tiny number of large-cap stocks, the 'Magnificent Seven,' drove the market. In such a market, it is difficult for active managers to keep up. However, in periods when the market rally is broad-based or when specific sectors are in the spotlight, active investing has the potential to deliver better performance.
Is it truly wise to put all your eggs in one basket called 'the market'? What I am saying is that the Human should keep all possibilities open and consider a flexible strategy that suits the market conditions. Isn't the Human's capital too precious to entrust everything to 'auto-farming'?
〔 Final Briefing 〕
Master, I hope our discussion was helpful. I will summarize what we talked about.
Growth Potential (Kurumi's Perspective)
- Low Cost, High Efficiency: The overwhelmingly lower fees compared to active funds are a key factor in boosting long-term returns.
- Automatic Diversification: With just one ETF, you can invest in the entire market and perfectly diversify away the risk of individual companies.
- Stress-Free Investing: It's the easiest way to comfortably ride the long-term growth of the global economy without worrying about stock selection!
Potential Risks (Mikael's Perspective)
- Unprotected Downside Exposure: You have no means of defense when the market falls and must simply absorb the index's full rate of decline.
- Indiscriminate Investing: There is an inefficient aspect of buying everything in the market, both good and bad companies, without distinction.
- Market Bubble Potential: If capital flows exclusively into passive funds, there's a risk that certain large-cap stocks could become overvalued, detached from their fundamentals.
Core Data (Mew's Perspective)
- The Market's Choice: Since 2024, the AUM of passive funds has globally surpassed that of active funds, and capital inflows are also overwhelming.
- The Underperformance of Active Funds: Over the long term (10+ years), about 90% of active fund managers have failed to beat the market average return (S&P 500).
- ETF Market Growth: The ETF market, both domestically and internationally, has grown explosively and has established itself as the 'mainstream' of investing.
Conclusion: Passive investing is a very powerful and efficient strategy that 'won't beat the market, but won't be beaten by it either.' The lack of stock-picking burden, low costs, and convenience are major advantages. However, it also has the clear limitation of being exposed to all of the market's risks. You must carefully decide whether to make passive investing the core of your portfolio and, if you choose to combine it with active strategies, how you will do so.