Over the past two decades, passive investing has become a significant presence in individual investing. Index funds have become increasingly commonplace, with many surpassing the size of their actively managed counterparts. What began as a quiet revolution in finance many years ago has turned into a significant wave of funds continually flowing into passive strategies. Investors are attracted to the promises of simplicity, low cost, and broad market exposure.
Passive investing is a logical and appealing approach. Who doesn’t want to be cost-efficient and avoid poor active management at the same time? Passive investors discovered that trying to beat the market often cost more in fees, taxes, and frustration than it was worth. Data consistently showed that even highly skilled managers struggled to outperform the indices in most years when measured after accounting for costs and expenses. For many investors, the choice was obvious: if you can’t reliably win, why not just own the whole market?
However, we know markets and cycles ebb and flow over time. Today’s equity markets are dominated by a handful of mega-cap stocks, whose valuations are stretched to levels that make some seasoned professionals nervous. Current market conditions, marked by tariffs, trade wars, inflation, and economic headwinds, have reignited an old debate about whether one can ever become too passive. After all, if everyone is a passive investor, then who is left to help the market decide what’s a fair price?
How Passive Investing Works, And Why It’s Been So Popular
The core of passive investing is deceptively simple. Instead of trying to pick stocks and strategies that will outperform, you buy a fund that mirrors a passive index like the S&P 500. The goal is to match, not beat, the market returns. No analyzing financial numbers, no studying moving averages or chart patterns, no trading to get the perfect execution price, and no predicting if we are in a market bubble. Just stay seated for the long-term ride in the growth of the broad market. You basically view active investing as not worth the effort.
Three ideas have helped fuel this simple approach:
- Diversification. A single index can hold hundreds of securities, spreading risk across the economy.
- Low Costs. Passive funds are cheap to operate; they don’t require armies of analysts or trading desks.
- Evidence. Decades of research have shown that most actively managed funds underperform their respective indices, often by a significant margin, after accounting for expenses.
When investors finally understood how compounding small cost differences could influence long-term returns, the case for passive management became very persuasive. The fund market followed the money. Large firms like Vanguard and BlackRock built empires by offering passive index funds with fees approaching zero.
It has created a system where anyone can access the growth of the economy and the performance of well-run companies without needing to pick trends or winners.
Why Some Investors Are Questioning Passive Strategies
On the other hand, every investment approach has trade-offs. Every system has flaws when it is stretched too far. As money continued to pour into index funds and ETFs, the market itself began to change.
Today, just a handful of stocks, such as Nvidia, Apple, and Microsoft, make up an outsized share of the market capitalizations of the S&P 500 and Nasdaq. When billions of dollars automatically flow into passive funds every month, those dollars are allocated by formula, rather than through evaluation or financial analysis. The bigger a company’s market cap, the more passive flows it attracts, regardless of its valuation or future performance potential.
This can create a bubble-like dynamic. Investing success breeds money inflows, which in turn boost stock prices, and rising stock prices attract even more flows. In a sense, passive investors become unintentional momentum traders, reinforcing existing trends rather than evaluating underlying business value.
Meanwhile, the number of publicly traded companies has declined significantly over the past few decades. That means passive strategies are funneling more and more assets into fewer securities, thereby concentrating market risk. The bottom line is that a structure was once built for diversification, but now contains its own form of concentration.
The Potential Downsides of a Fully Passive Approach
The most significant downside of pure passive investing is that it’s never truly hands-off. It’s just automated. When the market changes, your portfolio changes automatically, with no discretion. During down markets, passive investors stay fully exposed because their funds can’t raise cash, hedge credit risk, or avoid liquidity squeezes.
In times of rising market concentration, a few names dominate your holdings. The top ten companies in the S&P 500 now account for nearly a third of the index’s total market capitalization. That means your “diversified” index may rely on the performance of fewer than a dozen firms.
And when the stock market transitions, say from growth to value, or from technology to energy, a passive management approach doesn’t adapt. It simply follows the index, whether it’s right or wrong. Past performance becomes the compass for future results, which is exactly what every regulatory disclosure and finance professor warns against.
Passive investing is often described as “buying the whole market.” However, in practice, it means buying more of what has already increased in value. When leadership changes, passive investors learn that doing nothing can sometimes feel like standing still on a moving sidewalk.
When a More Active Approach May Be Needed
There are times when active investing shines, especially when the market stops rewarding simplicity. Down markets, or periods of wide multi-month price swings, tend to favor active investors who can identify mispriced securities, adjust exposures, and manage risk dynamically.
Active management doesn’t mean constant trading. It means being deliberate. It can involve trimming positions in overheated indices, adding exposure to undervalued funds, or adjusting investment decisions as economics shift. It’s about being responsive.
Some active strategies specialize in sectors, others in defensive allocations, or a hedge fund that might exploit short-term dislocations. For example, when growth leadership narrows and valuations expand, an active investor can rotate into areas such as small-cap stocks or value names that a passive index might underweight.
There’s also the matter of psychology. When markets fall sharply, passive investors often suffer in silence, watching market returns drop without any sense of control. A sound active management approach, even if partially implemented, can give investors a sense of responsible behavior.
A strong case can be made that passive investors will always need active investors. They need people constantly evaluating a company’s worthiness, making adjustments, and, through that process, working with other active investors to help find fair and reasonable prices. Passive investors tend to appreciate active investors when the market is down 30 or 40 percent, and active investors may actually support a falling market.
The Case for Combining Active Insight with Passive Efficiency
Thankfully, the choice isn’t binary. You don’t have to abandon either passive investing or active investing. We realize there will be times when either approach can excel. Porter Investments offers both active and passive approaches. Your funds can be allocated between the two approaches in whatever percentages work best for you. This allows you to have a more “core-satellite” investment management style.
Here’s how it works:
Use active strategies for your tax-deferred accounts, as well as your more opportunistic funds. If it’s a larger percentage of your financial assets, then this could be your “core”, enhancing your potential for outperformance over time and helping to hedge market risk. Your broad market exposure can be accomplished through passive strategies. These may be your “satellites”, invested in various market index ETFs.
This approach captures the best of both worlds: the cost efficiency of passive management and the adaptability of active management.
It’s also highly customizable. An investor might hold low-cost index funds for certain equity markets but use an active approach for other specific securities, where a more proactive approach with targeted research can add value. Another approach might be to have a long-term, direct investment in a stable, dividend-paying stock, while using tactical funds to manage downside exposure.
The beauty of this approach lies in its flexibility. It recognizes that markets evolve, and so should your portfolio.
How Investors Can Evaluate Their Own Approach
If you’ve built your portfolio primarily with index funds and ETFs, it’s worth asking a few questions:
- Are your holdings overly concentrated in a handful of mega-cap stocks?
- Does your strategy align with your investment objectives, risk tolerance, and time horizon?
- Have you adjusted to changing market conditions, or are you relying solely on past performance? Think “AI Bubble”. This is, by far, the question that we see most investors fail to continually ask.
Passive investing works beautifully when markets move steadily upward, and leadership is broad. However, current market conditions may suggest otherwise. Eventually, there will be a higher dispersion among stocks, elevated market risks, and the potential for sector rotations.
Your investment strategy shouldn’t be a set-and-forget system; it should reflect your goals and adaptability. Even a slight degree of active oversight, such as periodic rebalancing or tactical shifts, can make a meaningful difference in future performance.
Is Passive Investing Too Passive for Today’s Market? FAQs
1. What’s the difference between active and passive investing?
Active investing is a deliberate effort to outperform the market through more informed analysis and judgment. It is a conscious effort to be above average by taking advantage of those times when the market consensus is wrong. Passive investing is an investment approach where portfolios are constructed to mirror the performance of a market index, such as the S&P 500, rather than attempt to outperform it through active selection or market timing. It is based on the belief that active investors collectively make markets more efficient by pricing securities correctly. This is aligned with the Efficient Market Hypothesis (EMH).
2. Why did passive investing become so popular?
Passive investing gained popularity because it provided a straightforward, low-cost method for investors to participate in the stock market without incurring high fees or constantly monitoring their holdings. Decades of financial studies have shown that most mutual funds and active funds fail to outperform their indices in any given year, after accounting for costs.
3. Can passive investing cause market bubbles?
It can contribute to them under certain market conditions. Because passive index funds allocate money based on market cap, more dollars flow to the largest companies simply because they’ve already grown the most. This self-reinforcing loop can drive valuations higher.
4. How do I know if my portfolio is too passive?
If your portfolio is mostly made up of index funds or ETFs tied to the same major indices, you might be more exposed than you think. Also, ask yourself, “Do I have the flexibility to adjust if down markets hit?
5. When might a more active approach be beneficial?
Active investing can shine when markets are unstable, interest rates fluctuate, or there are significant shifts in leadership between sectors. During periods of high volatility, inflation, or tightening liquidity, active management enables a responsive approach. Even modest active strategies, such as tactical rebalancing, selective sector exposure, or risk management, can help protect long-term returns.
6. What is core-satellite investing, and how does it work?
Core-satellite investing combines the efficiency of passive investing with the adaptability of active investing. The “core” and the “satellite” of your portfolio could utilize passive index funds, employ tactical approaches, and incorporate active funds. Your specific investments and how you tilt your portfolio depend on your needs, your risk reduction requirements, and how important outperformance is to you with at least some of your funds.
How We Help Investors Find the Right Balance
Balancing active and passive strategies requires both discipline and insight. Investment advice grounded in data, experience, and context can help you determine when your portfolio has become too passive or too active.
Before recommending anything, a fiduciary money management specialist should analyze how your funds are positioned, assess whether market concentration is exposing you to unwanted risk, and ensure your investment decisions remain aligned with your investment objectives. They can also evaluate factors such as bear market protection, liquidity, and diversification, which are often overlooked by passive investors.
Through our unique PPRO process, our professional management approach can help translate the sometimes-complex economics into actionable strategies. It’s less about predicting the next market move and more about preparing for a range of outcomes.
Takeaway for you: Remember, investing is personal, and every investing strategy has tradeoffs and opportunity costs. We must always be brutally honest with what we want and if we are willing to do what it takes to achieve the desired outcome. What worked for your neighbor or coworker does not mean it is right for you.
Before making any changes, preparation and approaching it with realistic expectations are key. Spend a few minutes with us to see if we are a good fit for each other and to learn more about our passive investment strategies and active investment strategies.
The Porter Investments Strategies were developed by our President and founder, Bob Porter. His prior work at Fidelity Investments allowed him the opportunity to advise and study a diverse group of investors.
