Why Passive Investing Isn't Always the Answer

For decades, the gospel of personal finance has been simple: invest in diversified low-cost index fund, set it, forget it, and let the magic of the market make you wealthy. This "passive investing" strategy is built on a single, powerful belief: in the long run, markets always go up. It's an appealingly simple idea, and for many in the United States, it has worked beautifully. But this core belief isn't a universal law of finance, but rather the result of a specific, golden era of economic history. By "passively" buying the market, you are actually making a very active bet that the next 75 years will look similar to the last.

The Myth of the Always-Rising Market

The success of passive investing in the United States since World War II is undeniable. But it's crucial to understand why it worked. It was the result of a powerful combination of factors: the rise of the U.S. as a global superpower, decades of technological innovation, favorable demographics, and the dominance of American corporations. Passive investors weren't just buying "the market"; they were buying into the single greatest economic expansion in modern history.

To assume this is a preordained outcome ignores the passive investor in Japan who bought the Nikkei index in 1989 or plethora of investors who lost it all investing in equity markets that went to zero due to war or societal collapse. The truth is, markets don't just "go up." They follow the reality of economic growth, inflation, and corporate profits. Passive investing isn't truly passive as it's a bet that the specific economic tailwinds that benefited your home country in the past will continue blowing in the same direction, forever.

The 2022 Bond Market: A Wake-Up Call

For years, the standard "passive" portfolio was the 60/40 model: 60% in stocks for growth and 40% in bonds for safety. The logic was simple: when stocks go down, bonds go up, acting as a shock absorber. This relationship held for decades, reinforcing the idea that you could set your allocation and forget it.

Then came 2022. As inflation surged to 40-year highs, the Federal Reserve was forced to raise interest rates at a historic pace. This was a fundamental shift in the economic environment. The result? Both stocks and bonds plummeted together. The S&P 500 fell nearly 20%, but bonds, the supposed "safe" part of the portfolio, offered no protection. In fact, the U.S. bond market suffered its worst year in history, with the Morningstar U.S. Core Bond Index losing almost 15%.

Investors who had been told to blindly trust the 60/40 model learned a harsh lesson: when the underlying economic reality changes, historical correlations can break down completely. The "set it and forget it" strategy failed because it was based on a backward-looking assumption that didn't account for the new reality of high inflation.

Smart Investing is About Adapting, Not Assuming

The 2022 bond market was a powerful reminder that markets follow reality. Responsible investing requires an awareness of the macro environment, the economic "seasons" of growth and inflation, and positioning your portfolio accordingly.

Just as you wouldn't wear a winter coat in July, your portfolio shouldn't be positioned for a booming, low-inflation economy when the data is pointing to a slowdown with rising prices. An "all-seasons" approach doesn't try to predict the future, but it does react to the present. It analyzes the data to understand the current economic season and invests in the asset classes that are best suited for those conditions.

The idea of passive investing is comforting, but it's based on a flawed premise. It encourages you to make an active bet on the past repeating itself, which is probably not one you consciously intended to make. A truly resilient investment strategy is about having a framework to understand the ever changing global economy and the discipline to adapt.