The paradox of passive
Peter McGahan
Monday 10th August, 2026.
I LOVE a bargain. I also like brakes on a car. If someone offers me a cheaper car by removing the brakes, I don’t celebrate the saving. I ask how soon we meet the hedge. The message is that we don’t need breaks on straight roads. All straight roads have a bend at some point.
Passive investing has been one of the great consumer wins of the last half century. Trackers and exchange-traded funds (ETFs) have cut charges, exposed lazy active managers and given ISA and pension investors access to markets at costs that once sounded like fantasy.
But every good idea has a point at which it stops being a tool and becomes a fashion. That is where the paradox begins.
Passive investing works because it takes a cheap ride on an active market. Somewhere, someone is reading accounts, challenging directors, deciding whether a share is expensive, cheap, brilliant or bonkers. The passive fund does not need to do all that work. It buys the index and keeps costs down.
That is perfectly sensible for one investor. It may be sensible for millions. But if too much money does the same thing, the question changes. Who is still doing the work?
The Financial Conduct Authority (FCA) made the point in its research on passive investing and market quality. Passive has lowered costs and increased competition. Good. But active management also supports the research, trading and monitoring needed for an equity market to work properly. If enough investors choose passive, those individually sensible decisions may, in aggregate, damage market quality and wider economic performance.
That is the paradox of passive. One person saving money is thrift. Everyone saving at once can damage demand. One person using a tracker is sensible. Everyone using the same tracker can change the market they are trying merely to observe.
Recent performance numbers explain why many in the crowd is moving of course.
Trackers were sold as “the market minus tiny costs”. If they deliver far more than the average active fund, is that just genius simplicity, or is something else happening underneath?
When money pours into market-cap-weighted funds, it goes disproportionately into the largest companies. Their prices rise, their index weights rise, and the next pound
into the tracker buys more of them again, just because demand is inflating price as opposed to increased value. Strong performance then attracts more money from investors and platforms looking in the rear-view mirror. Round it goes.
This is not immoral. It is not a conspiracy. It is plumbing. And plumbing matters most when the pressure changes.
In a rising market, those flows make passive investing feel inevitable. In a falling market, the same machinery can work backwards. If investors sell trackers, the fund sells what the index owns. If the index is concentrated in what everyone already owns, the selling pressure is concentrated too. Add momentum traders, algorithms and nervous investors approaching retirement, and the exit door that looked wide at the beginning of the wedding suddenly looks tiny when everyone wants a taxi.
We should be careful here. Dramatic predictions about passive creating repeated 1987-style market breaks are scenario thinking, not fact. Markets adapt. Active investors do not vanish because someone declares them extinct. Valuation still matters, eventually, because cashflow tends to return to the room like the wise schoolteacher.
The uncomfortable truth is that passive funds can be both sensible and systemically awkward. Low charges help the individual saver. Heavy, one-way flows can distort prices. Broad diversification can reduce company-specific risk. Market-cap weighting can quietly concentrate your money into whatever has already gone up. A simple fund can hide a complex market structure.
That does not make passive investing bad. It makes blind passive investing bad.
For UK savers, the practical point is not to throw trackers out of ISAs and pensions in a fit of financial theatre. Most investors have benefited from lower charges, and many expensive active funds deserved to be chased out of town with a stick of rhubarb anyhow. Paying more for mediocrity isn’t wise.
But we do need to stop treating passive as if it were a moral category. It is not purity. It is a method. It is a decision to accept the index’s construction, concentration, flows, rebalancing rules and view of the world.
The paradox is simple: passive succeeds by relying on active markets. If too many investors free ride on the same system, the free ride may stop being free.
So, keep the bargain. Just check the brakes.
I will be creating a guide to investing, so, if you would like a complimentary copy, please email info@wwfp.net.
Peter McGahan is the Chief Executive Officer of Independent Financial Adviser firm, Worldwide Financial Planning. Worldwide Financial Planning is authorised and regulated by the Financial Conduct Authority.
