Over the years we’ve seen a major shift toward passive investing, largely driven by regulatory encouragement for individuals to fund their own retirements through vehicles like 401(k)s. To facilitate this, mutual fund companies were enlisted to offer age-based portfolios—commonly known as target-date funds. These portfolios typically start with heavy allocations to stocks like the S&P 500 for younger investors and shift toward bonds as retirement approaches.
At the heart of this shift is the S&P 500, a cap-weighted index, which means more money flows into the largest companies. As passive money consistently enters these index funds, more capital is allocated to mega-cap stocks—regardless of valuation or fundamentals. This distorts market pricing, as these inflows are “non-thinking money”—capital going in without regard for earnings, value, or individual company analysis. This is a dramatic departure from traditional investing, which focused on value and fundamentals.
Now, consider what happens as older investors begin withdrawing funds. They represent the “thinking money”—seasoned, valuation-aware capital. Their withdrawals through Required Minimum Distributions (RMDs) at age 73 (recently raised from 70½) are essentially draining that thoughtful capital from the market. Meanwhile, younger investors, largely passive, keep funneling funds into index funds without questioning valuations or risk.
This dynamic creates an environment ripe for market distortion. The government may have extended the RMD start age in part to slow the outflow of this "thinking money" from the markets. But as that older cohort continues to draw down their retirement assets, a greater share of the market becomes driven by passive flows—momentum-based, automatic buying with no consideration for price.
This passive dominance is potentially dangerous. If a major event spooks investors, the first reaction will likely be massive redemptions from index funds, triggering sharp declines in the largest stocks—which carry the most weight. This could cascade into a broader selloff or even a market crash, especially with fewer active, value-driven investors willing to step in and buy the dip.
Therefore, for investors approaching or in retirement, it may be time to reduce exposure to equities, especially high-risk index-heavy portfolios, and instead consider bonds, preferred stocks, or other income-generating assets. These may not offer explosive returns, but they help preserve capital—which becomes more important as you age.
We’ve seen quick recoveries from past drops like in 2008 and 2022, but the next downturn might not rebound as easily—especially if there's not enough active, valuation-driven capital left to support a recovery.
As an example, if a retiree has $1 million in an IRA and takes a $40,000 RMD, that money leaves the value market—permanently. To offset that, it takes many younger investors contributing smaller amounts to replace it. But again, their contributions go to the index, not based on value. Over time, this feedback loop further inflates large-cap valuations while starving smaller, potentially undervalued companies of capital.
Bottom Line:
The passive-investing era has created new risks. The market’s structure is changing, and with it, so is its resilience. As we age, capital preservation and dependable income may matter more than chasing high returns. Being mindful of this shift may help protect your portfolio in a future where thinking money is no longer driving the market.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful. Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take into account the effects of inflation and the fees and expenses associated with investing. The return and principal value of stocks fluctuate with changes in market conditions. Shares when sold may be worth more or less than their original cost. The return and principal value of bonds fluctuate with changes in market conditions. If bonds are not held to maturity, they may be worth more or less than their original value. The target date of a target date fund may be a useful starting point in selecting a fund, but investors should not rely solely on the date when choosing a fund or deciding to remain invested in one. Investors should consider funds' asset allocation over the whole life of the fund. Often target date funds invest in other mutual funds and fees may be charged by both the target date fund and the underlying mutual funds. The principal value of these funds is not guaranteed at any time, including at the target date.