Quote from Early Retirement Extreme

[Zola.]

Currently reading this book and came across a section that I thought may spark discussion...

Thoughts on this?

“This has resulted in the growing popularity of "buy and hold" index funds, which simply mimic what everybody else is doing, on average, at less cost. Of course, the emerging behavior of such a strategy is eventual chaos, as nobody leads and everybody follows each other.

Buy and hold is an investment strategy with no exit strategy. What this typically means is that stocks are usually liquidated when money is needed, rather than taking into account when a given stock is overvalued. The aggregate effect of workers investing in this manner is to turn the stock market into an elaborate demographical Ponzi scheme, where the value of investments depends on how many people are retiring and how many people are entering the labor market.

In particular, it depends on the level of confidence that the most recent entrant has in the system, and hence this becomes a policy matter. Diversification doesn't prevent the effects of something as systemic as this. Instead, it reinforces the problem, as everybody behaves the same.”

Excerpt From: Fisker, Jacob Lund. “Early Retirement Extreme: A philosophical and practical guide to financial independence”. Apple Books.

[Imma]

I'm at work now, so I can't write a long response. I'm posting to follow this and I just wanted to say that this topic is discussed frequently at my dinner table with a relative who worked at an investment bank.

[singpolyma]

As with most market things, index funds are simple at a first level, bonkers at a second level (as per your quote), and fine again at a third level.

If so many people were to just buy and hold index funds so as to open up the possibility that an active strategy would perform better, someone would use that strategy and effectively arbitrage the index fund's influence, attracting people and taking them out of index-buy-and-hold.

[Johnny Aloha]

Index funds are not perfect, nor do they claim to be.  There are real risks related to liquidity and capital gains that are remote but significant.  But the tradeoff is you get a diversified portfolio for a very low cost.

Consider the alternatives: DIY fund picking, DIY stock/bond picking, etc.  Given everything we know about psychology, behavioral economics, and actual returns investors have experienced ... index funds are the "best" or "least bad" options available to most people.

For further reading on these risks:
https://www.thebalance.com/investing-in-index-funds-for-beginners-356318
https://www.joshuakennon.com/sp-500s-dirty-little-secret/

[matchewed]

Well I think that Jacob falls into the idea that everyone is doing the same thing at the same time and what does that do scenario. The reality is that people are not all selling at the same time. As people are selling others are buying.

It's more of a slippery slope fallacy than anything.

[terran]

Yes, if literally everyone indexed you'd have no one determining the true value of the underlying assets. But you really don't need very many trying to beat the market to set a fair price that the index can then follow. And if you had very few people trying to beat the market and more indexing, then beating the market would become easier so more people would do it thereby increasing the efficiency of the market. It's a self correcting problem -- all you need is enough people trying to find the right price and the right price will become the current price.

[Milizard]

I think he's underestimating people's greed.  How many people always want just a little bit more than the person next to them?  Or even a lot more?  Or a higher income?  Or just enjoy winning some competition in their heads?  I think it's a lot.

[I'm a red panda]

The index strategy wouldn't work if everyone was doing it.  But not everyone is doing it.

[Zola.]

But is increasingly popular every day.

I do wonder what he invested in as it sounds like he is somewhat against it.

[matchewed]

You can read his website and glean generalities. He actively traded/trades. And that is fine but it isn't necessarily a winning strategy for all people as well.

[Zola.]

Just finished that book, it was dry as hell, quite boring and robotic actually.

I went from reading JL Collins 'The Simple Path To Wealth" which was a lovely book and a pleasant read, to this long and drawn out book.  I ended up skimming a fair bit of it towards the end.