Authored by Lance Roberts via RealInvestmentAdvice.com,

In Tuesday’s post, “A Shot Across The Bow,” I discussed the recent “Tech Wreck” and the warning sign that was delivered when trading algorithms begin to run in the same direction. To wit:

“The plunge was extremely sharp but fortunately regained composure and shares rebounded. A ‘flash crash.’ One day, we will not be so lucky. But the point I want to highlight here is this is an example of the ‘price vacuum’ that can occur when computers lose control. I can not stress this enough. This is THE REASON why the next major crash will be worse than the last.”

Of course, it generally isn’t long after publishing commentary about the dangers of the current crowding into ETF’s, that I receive some push back.

Shocker: For fee broker advises against indexing https://t.co/VfCIYBEMnp — JiveJoseph_Duarte (@JiveJoey_D) June 13, 2017

First, I am not a “broker.” I am a “fee-only” investment advisor which operates under the “fiduciary standard.” While we do charge a below average fee for our services, our focus is on capital preservation and total portfolio returns to achieve our client’s long-term financial planning goals. Our client, and most importantly their hard earned savings, are our priority. (Read more in “The Financial Manifesto.”)

Secondly, I find a consistent uniformity of those who have fallen victim to the “buy and hold” and “passive indexing” mantra such as:

They have never been through a major bear market.

Have done little, if any, historical analysis with respect to market dynamics.

Are generally very aggressively exposed to the markets leading to a need for “confirmation bias.”

“confirmation bias.” Have little or no understanding of the impact of loss with respect to long-term outcomes.

impact of loss with respect to long-term outcomes. Are generally investing with very small sums of money in the hopes of building exponential wealth.

Believe in the long debunked theory of “compounded returns” in the markets.

Lastly, these individuals are NOT “passive” investors. They are simply “passive holders” while markets are rising and will become “active sellers” during the next significant decline.

However, let me clear, I am certainly NOT against using “indexed based” ETF’s for managing exposure to the markets for individuals who wish to have:

Lower trading costs Higher tax efficiencies Less turnover Lower volatility Access to asset classes not covered in a traditional equity portfolio

But gaining access to those benefits does NOT mean being oblivious to the underlying risk of ownership. The firm I manage money for runs both an all-ETF strategy, as well as a blended ETF/Equity portfolio, we also apply a very strict set investment rules toward the management of “risk” in the portfolio. In other words, the entire practice adheres to Warren Buffet’s primary rules on investing:

Don’t Lose Money Refer To Rule No. 1.

As is always the case, the time spent making up lost capital is far more detrimental to the long-term investment outcome than simply recouping a missed opportunity for gains.

Which is the point of today’s post.

Rise Of The Machines

While I have written often on the dangers of both ETF’s and “Passive Investing” (See here and here), my friend Evelyn Cheng highlighted confirmed the same yesterday.

“Quantitative investing based on computer formulas and trading by machines directly are leaving the traditional stock picker in the dust and now dominating the equity markets, according to a new report from JPMorgan. ‘While fundamental narratives explaining the price action abound, the majority of equity investors today don’t buy or sell stocks based on stock specific fundamentals,‘ Marko Kolanovic, global head of quantitative and derivatives research at JPMorgan, said in a Tuesday note to clients. Kolanovic estimates ‘fundamental discretionary traders’ account for only about 10 percent of trading volume in stocks. Passive and quantitative investing accounts for about 60 percent, more than double the share a decade ago, he said.”