Author Topic: Index fund "bubble" about to burst?  (Read 14652 times)

OmahaSteph

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Index fund "bubble" about to burst?
« on: November 22, 2016, 09:24:09 AM »
Read this today on Investopedia. I'm admittedly not fluent in investing (which is one of the reasons I like passive index funds), so can we discuss this and what it means for all of us? I imagine it depends greatly on where you are in relation to retirement.

http://www.investopedia.com/articles/investing/112116/it-time-prepare-index-fund-sell.asp


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Re: Index fund "bubble" about to burst?
« Reply #1 on: November 22, 2016, 09:29:55 AM »

This is what I read when I read that article:
"There will be a market reset someday."   (Sure.  Of course there will)
"Some idiots will sell off their investments in a panic."  (Again: absolutely true.)
"A lot of those investments will be in index funds." (Yes, because index funds are a good chunk of what is being invested in.)
"And smart fund managers will see a lot of bargains out there when the index funds sell.  They will buy them."  (Yes.  That's what happens when stuff is cheap.  People with the cash will grab up all the bargains.)
"And therefore you should invest with managed funds."  (Um... that conclusion is really not supported by the above.)

arebelspy

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Re: Index fund "bubble" about to burst?
« Reply #2 on: November 22, 2016, 09:56:47 AM »
Right.  When the market falls, you should buy more.  What should you buy more of?  Index funds!   (Because you probably can't tell which companies will do better than the index, nor can most managers, and the ones that can probably can't do it well enough to out earn their fees, and those that can, you probably can't pick them.)

If you have no funds to buy more (ER'd), you should stay the course.  Drop spending or earn a bit more, if possible/necessary.

This article is silly, their conclusions are completely unsupported and unrelated to anything factual in the article.
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OurTown

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Re: Index fund "bubble" about to burst?
« Reply #3 on: November 22, 2016, 10:02:01 AM »
Investopedia = financial porn.  Also, not very good porn.

FIKristen

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Re: Index fund "bubble" about to burst?
« Reply #4 on: November 22, 2016, 10:18:36 AM »
I don't believe in market timing.  However, I do believe that the market is overvalued when looking at the usual metrics. And I do question the relentless "buy in - even if the market is overvalued" advice that sometimes appears on these forums.  If you are at all risk averse, you may do well to seek other investment opportunities right now. 

arebelspy

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Re: Index fund "bubble" about to burst?
« Reply #5 on: November 22, 2016, 10:29:46 AM »
I don't believe in market timing.  However, I do believe that the market is overvalued when looking at the usual metrics. And I do question the relentless "buy in - even if the market is overvalued" advice that sometimes appears on these forums.  If you are at all risk averse, you may do well to seek other investment opportunities right now.

The whole rest of your post literally contradicted your first sentence.  If you want to time, that's fine... just accept it, and own it.  No need for cognitive dissonance.

The market crashing, or market timing, was not quite what this article was arguing though.  It was arguing passive vs active.  I think maybe the title mislead you into thinking it was about the market being in a bubble, but it was talking about the concept of index funds, not their value, per se.
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Re: Index fund "bubble" about to burst?
« Reply #6 on: November 22, 2016, 11:14:40 AM »
Read this today on Investopedia. I'm admittedly not fluent in investing (which is one of the reasons I like passive index funds), so can we discuss this and what it means for all of us? I imagine it depends greatly on where you are in relation to retirement.

http://www.investopedia.com/articles/investing/112116/it-time-prepare-index-fund-sell.asp

Go on a low information diet and save yourself a lot of grief.

http://www.mrmoneymustache.com/2013/10/01/the-low-information-diet/

This applies equally well to investment news as it does regular run of the mill news.

TexasRunner

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Re: Index fund "bubble" about to burst?
« Reply #7 on: November 22, 2016, 02:26:18 PM »
Investopedia = financial porn.  Also, not very good porn.

Lol!  This description!

bigend

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Re: Index fund "bubble" about to burst?
« Reply #8 on: November 22, 2016, 04:17:40 PM »
It reads like an advert by active managers trying to sell their funds, e.g.

Quote
Rogers hosted a panel discussion last week in Chicago with three other portfolio managers where they discussed a range of financial topics. He predicted that when the markets eventually drop, the frenzied selling that index funds will have to do will create substantial buying opportunities for active traders and managers.

If most investors truly converted to passive investing they will not sell and index funds wouldn't sell either (still we must recognize that indeed most investors will still panic and sell at wrong moment)

Quote
They [active managers] will be able to pick up quality stocks at a substantial discount from their current prices and can also hold onto those holdings that they feel will rebound quickly.

I don't understand why you can't do this as an individual with an index fund (i.e. buy when prices drop and hold for a rebound). The active managers selling point is that they will hold your cash for you and deploy when market drops? Thank you but if I want to play market timing I prefer to hold the cash myself...

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Re: Index fund "bubble" about to burst?
« Reply #9 on: November 22, 2016, 04:35:26 PM »

This is what I read when I read that article:
"There will be a market reset someday."   (Sure.  Of course there will)
"Some idiots will sell off their investments in a panic."  (Again: absolutely true.)
"A lot of those investments will be in index funds." (Yes, because index funds are a good chunk of what is being invested in.)
"And smart fund managers will see a lot of bargains out there when the index funds sell.  They will buy them."  (Yes.  That's what happens when stuff is cheap.  People with the cash will grab up all the bargains.)
"And therefore you should invest with managed funds."  (Um... that conclusion is really not supported by the above.)


"There will be a market reset someday."   (Sure.  Of course there will)
"Some idiots will sell off their investments in a panic."  (Again: absolutely true.)
"A lot of those investments will be in active funds."(Yes, because active funds are a good chunk of what is being invested in.)
"And dumb fund managers will see a lot of crap out there when the other active funds sell.  They will buy them."  (Yes.  That's what happens when stuff is cheap.  People with the cash will grab up all the bargains.)
"Then those active funds will continue to go on underperforming index funds, just like they did the last time we had a big crash in '08"
"And therefore you should invest with index funds."  (Um... that conclusion is really not supported by the above.)

It can go either way.

Conclusion: stick with index funds.

MustacheAndaHalf

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Re: Index fund "bubble" about to burst?
« Reply #10 on: November 22, 2016, 07:40:21 PM »
"John Rogers, lead portfolio manager for the $2 billion Ariel Fund, believes that there is a growing bubble in the market indices ..."
"Active portfolio managers may be wise at this point to start accumulating cash that they can use to buy back into the markets if Roger’s prediction is correct and the bubble does indeed burst ..."

And yet John Rogers has the Ariel fund 99% invested in mid- and small-cap value stocks.  Not cash.
http://portfolios.morningstar.com/fund/summary?t=ARGFX&region=usa&culture=en-US
In other words:
"Be so afraid of the market and sell me your small and mid cap value stocks, because I'm buying them."

Mighty-Dollar

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Re: Index fund "bubble" about to burst?
« Reply #11 on: November 22, 2016, 08:18:29 PM »
This talk about an index fund bubble probably got started by an active manager. Is money going to start flowing OUT of my S&P 500 index fund in favor of actively managed funds. I don't believe it. Not as long as index funds keep outperforming managers year after year.

The markets are actually more efficient because of index funds. One more reason to stick with index funds instead of active managers.

If you believe the hysteria then just buy a total stock market index fund and not worry about it. It's a zero sum game therefore the total stock market should not be affected.

arebelspy

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Re: Index fund "bubble" about to burst?
« Reply #12 on: November 22, 2016, 08:57:49 PM »
"John Rogers, lead portfolio manager for the $2 billion Ariel Fund, believes that there is a growing bubble in the market indices ..."
"Active portfolio managers may be wise at this point to start accumulating cash that they can use to buy back into the markets if Roger’s prediction is correct and the bubble does indeed burst ..."

And yet John Rogers has the Ariel fund 99% invested in mid- and small-cap value stocks.  Not cash.
http://portfolios.morningstar.com/fund/summary?t=ARGFX&region=usa&culture=en-US
In other words:
"Be so afraid of the market and sell me your small and mid cap value stocks, because I'm buying them."

Hah!  Good find!
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Eco_eco

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Re: Index fund "bubble" about to burst?
« Reply #13 on: November 22, 2016, 09:28:07 PM »
This talk about an index fund bubble probably got started by an active manager. Is money going to start flowing OUT of my S&P 500 index fund in favor of actively managed funds. I don't believe it. Not as long as index funds keep outperforming managers year after year.

The markets are actually more efficient because of index funds. One more reason to stick with index funds instead of active managers.

If you believe the hysteria then just buy a total stock market index fund and not worry about it. It's a zero sum game therefore the total stock market should not be affected.

This is so true - just more negative comments from someone with a vested interested. They are basically saying 'don't go with a methods of investing that's been proven to work through the market's highs and lows for the last 40 years, instead trust me - I can take all the stress of this away for just 2% of your portfolio a year'.

Fear = more profits for fund managers.

OurTown

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Re: Index fund "bubble" about to burst?
« Reply #14 on: November 23, 2016, 07:07:13 AM »
Read this today on Investopedia. I'm admittedly not fluent in investing (which is one of the reasons I like passive index funds), so can we discuss this and what it means for all of us? I imagine it depends greatly on where you are in relation to retirement.

http://www.investopedia.com/articles/investing/112116/it-time-prepare-index-fund-sell.asp

Go on a low information diet and save yourself a lot of grief.

http://www.mrmoneymustache.com/2013/10/01/the-low-information-diet/

This applies equally well to investment news as it does regular run of the mill news.

This is exactly what I've been doing since Nov. 9!

index

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Re: Index fund "bubble" about to burst?
« Reply #15 on: November 23, 2016, 10:37:49 AM »
The fundamental problem with index funds is market cap weighting. Flows out of bond funds, and actively managed funds into S&P 500 based index funds that are concentrated into the largest companies.

The S&P 500 index by percentage:
10% allocation to  3 companies - AAPL, GOOG, MSFT
20% allocation to 10 companies - BRK, XOM, AMZN, JNJ, FB, GE, JPM
50% allocation to 50 companies

If 50% of the money flowing into index funds is used to buy shares in only 50 companies (32% by market cap are in the tech sector), what do you think the price of those shares are going to do? Index investors are not nearly as diversified as they think and it will come back to bite them sometime in the future. To see what you, as an index investor are really buying right now, take a look at the holdings of the etf XLG which holds the top 50 largest S&P components.

The funny thing is we had almost this exact same situation with the Nifty 50 back in the 1960's. It didn't turn out too well. 

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Re: Index fund "bubble" about to burst?
« Reply #16 on: November 23, 2016, 11:30:31 AM »
The fundamental problem with index funds is market cap weighting. Flows out of bond funds, and actively managed funds into S&P 500 based index funds that are concentrated into the largest companies.

The S&P 500 index by percentage:
10% allocation to  3 companies - AAPL, GOOG, MSFT
20% allocation to 10 companies - BRK, XOM, AMZN, JNJ, FB, GE, JPM
50% allocation to 50 companies

If 50% of the money flowing into index funds is used to buy shares in only 50 companies (32% by market cap are in the tech sector), what do you think the price of those shares are going to do? Index investors are not nearly as diversified as they think and it will come back to bite them sometime in the future. To see what you, as an index investor are really buying right now, take a look at the holdings of the etf XLG which holds the top 50 largest S&P components.

The funny thing is we had almost this exact same situation with the Nifty 50 back in the 1960's. It didn't turn out too well.

So...put your money in more diversified indexes than SPY? Not that hard to get good market cap weighting as an index investor with just a tiny bit of DYI.

index

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Re: Index fund "bubble" about to burst?
« Reply #17 on: November 23, 2016, 01:52:09 PM »
The fundamental problem with index funds is market cap weighting. Flows out of bond funds, and actively managed funds into S&P 500 based index funds that are concentrated into the largest companies.

The S&P 500 index by percentage:
10% allocation to  3 companies - AAPL, GOOG, MSFT
20% allocation to 10 companies - BRK, XOM, AMZN, JNJ, FB, GE, JPM
50% allocation to 50 companies

If 50% of the money flowing into index funds is used to buy shares in only 50 companies (32% by market cap are in the tech sector), what do you think the price of those shares are going to do? Index investors are not nearly as diversified as they think and it will come back to bite them sometime in the future. To see what you, as an index investor are really buying right now, take a look at the holdings of the etf XLG which holds the top 50 largest S&P components.

The funny thing is we had almost this exact same situation with the Nifty 50 back in the 1960's. It didn't turn out too well.

So...put your money in more diversified indexes than SPY? Not that hard to get good market cap weighting as an index investor with just a tiny bit of DYI.

True, but VTI, which seems to be the gold standard here, is 41% weighted in the same 50 companies. The S&P is just an example. This is a pervasive problem across all index funds.

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Re: Index fund "bubble" about to burst?
« Reply #18 on: November 23, 2016, 02:08:48 PM »
Read this today on Investopedia. I'm admittedly not fluent in investing (which is one of the reasons I like passive index funds), so can we discuss this and what it means for all of us? I imagine it depends greatly on where you are in relation to retirement.

http://www.investopedia.com/articles/investing/112116/it-time-prepare-index-fund-sell.asp

If you want to understand why "experts" are saying the markets are overpriced then you need to read about CAPE.

https://en.m.wikipedia.org/wiki/Cyclically_adjusted_price-to-earnings_ratio

You can find a table here that shows America is overpriced and forms a large chunk of the overall market weighting

http://www.starcapital.de/research/stockmarketvaluation

Once you have read this you can understand why it's being said and then most likely just carry on doing what you are doing.

If the market drops you can buy more. I guess if you are getting to an age where you are unlikely to be able to earn any more money you could take it all a bit more seriously, but ultimately markets will go up and down and a little bit of down is good in the accumulation phase of your life.


effigy98

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Re: Index fund "bubble" about to burst?
« Reply #19 on: November 23, 2016, 02:47:09 PM »
Index funds are the worst possible investment you can make. You are just throwing money away every month!!!

This is the kind of advice that seems common in our culture because someone is trying to sell you shit (more fees!). There is a 99.9% chance that my .03% fee total market index fund is going to beat every active fund over the long term.

Livewell

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Re: Index fund "bubble" about to burst?
« Reply #20 on: November 23, 2016, 03:26:32 PM »
There is no doubt that an active manager can beat the index.  The vanguard studies show that, however it's difficult to do it over the long term.

If you want to try to be that person, and spend the time to make that happen, and maybe get lucky, great.  For me index funds gave me a way to capture the majority of the gains, consistently, with zero effort other than clicking a few buttons, saving time and stress.

For those not convinced, try doing a small amount of money in active management or individual stocks.  See how you do and if you have what it takes over a few years. 

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Re: Index fund "bubble" about to burst?
« Reply #21 on: November 23, 2016, 04:26:57 PM »
There is a 99.9% chance that my .03% fee total market index fund is going to beat every active fund over the long term.

There is no doubt that an active manager can beat the index.  The vanguard studies show that, however it's difficult to do it over the long term.

How do you reconcile these two seemingly contradictory statements. To me the active manager may inconsistently beat the market. They beat it one year but lose the next year. I'll stick with index investing.

arebelspy

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Re: Index fund "bubble" about to burst?
« Reply #22 on: November 23, 2016, 05:29:22 PM »
There is a 99.9% chance that my .03% fee total market index fund is going to beat every active fund over the long term.

There is no doubt that an active manager can beat the index.  The vanguard studies show that, however it's difficult to do it over the long term.

How do you reconcile these two seemingly contradictory statements. To me the active manager may inconsistently beat the market. They beat it one year but lose the next year. I'll stick with index investing.

1) Those statements are from two different people
2) They both agree, they aren't contradictory.  They both say that over the long run, the active manager won't beat the index (well the second statement calls it "very difficult" at least, but basically agreeing).

Anyone can beat it over a short time frame due to luck/randomness..just like you can beat a roulette wheel by betting red or black, and in the short term, win.  That doesn't mean it's a winning strategy long term.
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Re: Index fund "bubble" about to burst?
« Reply #23 on: November 23, 2016, 07:13:47 PM »
-VTI...  ...is 41% weighted in the same 50 companies. The S&P is just an example. This is a pervasive problem across all index funds.

It is though?

I'm big into Vanguard and Fidelity's Mid-Cap Index funds (VIMAX and FSCKX -fairly identical) partly because they don't have any MEGA caps that you reasonably note as a concentration problem. Top ten holdings = 6.8% of assets. FAR less than the 41-50% you noted for Total/500 Indexes. But Vanguard actually shows 16% & 19.5% for the top ten holdings of Total and 500, so don't know where you got 41% & 50%?

I'm sure the Small Cap index is even more spread out, but I like the Mid Cap funds since it's really a Large/Mid fund filled with all well-established big names with room to grow. Like you implied, 500 and Total market funds (roughly identical) are mainly MEGA Cap funds. People are riding ~15+% of their savings on ~10 companies (assuming a split w/ bonds in 'typical' portfolios). I don't trust future iPhones or Big Oil quite that much.

I also bounce back and forth between the two Mid funds and the 500 and Total Mkt. funds to do tax gain harvesting. Let's me sell big blocks of investments year after year while effectively remaining a die-hard buy n' hold'r. Let's you do a little rebalancing within equities, too during big peaks/crashes that you can't do if you're just in a 500 or Total Index alone.

I recommend people consider splitting assets between a MidCap Index and 500(or)Total Market (~50/50 give or take a tilt either way). That focuses you on ~900 main holdings, cuts the MEGA Cap overweight in half, and makes the slightly more volatile Mids even less so. Mid Index usually follows the total market almost perfectly, but has historically done a good deal better, mostly avoided the horrible 3-year dot com bubble, and though it crashed harder than Large Caps in 2008, it recovered 100% just as fast.
« Last Edit: November 23, 2016, 07:28:01 PM by AZryan »

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Re: Index fund "bubble" about to burst?
« Reply #24 on: November 24, 2016, 04:23:29 AM »

Go on a low information diet and save yourself a lot of grief.

http://www.mrmoneymustache.com/2013/10/01/the-low-information-diet/

This applies equally well to investment news as it does regular run of the mill news.

This is sound investing advice. Getting too caught up in the echo chamber of financial news has made more people poor than has made rich.

FIKristen

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Re: Index fund "bubble" about to burst?
« Reply #25 on: November 24, 2016, 10:44:21 AM »
I don't believe in market timing.  However, I do believe that the market is overvalued when looking at the usual metrics. And I do question the relentless "buy in - even if the market is overvalued" advice that sometimes appears on these forums.  If you are at all risk averse, you may do well to seek other investment opportunities right now.

The whole rest of your post literally contradicted your first sentence.  If you want to time, that's fine... just accept it, and own it.  No need for cognitive dissonance.

The market crashing, or market timing, was not quite what this article was arguing though.  It was arguing passive vs active.  I think maybe the title mislead you into thinking it was about the market being in a bubble, but it was talking about the concept of index funds, not their value, per se.

You're right - the article was talking about the concept of index funds, not their value, per se.

But before you dismiss me, allow me to explain where I was coming from.

In his book A Random Walk Down Wallstreet (recommended by this blog), Burton Malkiel  lays out an excellent and persuasive case for index fund investing as a long-term strategy.  He also includes in his book the historical 10-year returns from index investing when the market is at various PE ratios - unsurprisingly, the higher the schiller PE ratio, the lower average returns for the next decade.   Perhaps someone here has a copy of the book on hand right now and can post that graph here, but I seem to recall that historical 10 year returns at today's ratios were somewhere around 2%.   Not really that great.   If I had extra cash and found an alternative investment vehicle more likely to produce better returns over the next decade (rehab a duplex rental property for instance), I would find that very compelling.

arebelspy

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Re: Index fund "bubble" about to burst?
« Reply #26 on: November 24, 2016, 10:57:25 AM »
the higher the schiller PE ratio, the lower average returns for the next decade.

No doubt. 

But the thing is: you have to have somewhere to stick the money.  Whether that's gold, cash, commodities, bonds, stocks, real estate, whatever...

The market may have lower than average returns going forward in the short term, but it still may be better than everything else.  And without a crystal ball, we just don't know.

Given that everything ELSE looks overvalued, too.  The bond market is at historically ridiculously low rates, so has not much elsewhere to go but up.  Real estate has been driven up over the last 4-5 years.

Quantitative easing has put the world awash in funds searching for yield, driving all assets up, and lowering the forward looking expected returns on everything.

Thus you see so many companies hoarding cash (see Berkshire, or Apple, for examples).  And you see TONS of companies doing stock buybacks.

Quote
If I had extra cash and found an alternative investment vehicle more likely to produce better returns over the next decade

There's the rub.  The market IS overvalued. Yet it still seems like the best place to put your investments, IMO.
 Because it's hard to find anything that isn't overvalued, without chasing yield and ending up way riskier than you should, giving you quite poor risk adjusted returns (with things like peer to peer lending, or crowd sourced real estate investment sites).

So I vote: stay the course.

YMMV, of course.  :)
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Re: Index fund "bubble" about to burst?
« Reply #27 on: November 24, 2016, 01:49:22 PM »
Well said (above).

People, remember concentration in the top stocks is an effect, not a cause.

Those stocks have a high value because the market believes they will earn the lions share of profits.

We live in a world where for certain industries monopoly-like powers can exist, and in these capital intensive areas a competitive advantage may be sustainable.  In these areas it requires market strength and capital to compete or match the advantages.  Walmart and Costco spent a lot of time building stores and training their customers.  This is worth something.  GE spent a lot of intellectual capital to build their surgical equipment products, supply chain, relationships with hospitals, etc.  The market recognizes these assets and hence a few companies are worth a lot.

Generally speaking, the most likely value for a stock is what the price is at any one specific time.  Anyone who shouts over or undervalued is usually trying to get their hand on your wallet.

Buy VTI, stash some emergency currency at the bank of your choice and relax.  Focus on spending wisely and living well.  That's my advice.
« Last Edit: November 24, 2016, 01:53:14 PM by PizzaSteve »

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Re: Index fund "bubble" about to burst? Dur
« Reply #28 on: November 24, 2016, 04:04:04 PM »
I can guaranty that there are active managers who will beat similar index funds that match their style.  I can also guaranty that you can't (and nobody can) figure out ahead of time which managers those will be.  Very, very often, the highest flying fund of the year follows up by being THE worst performing fund the next year....so you can't go by history. 

Fidelity did a report last year that I can't seem to find.  They evaluated 401k owners in their funds and looked at returns.  Who did the best?  Active?  Nope  Passive?  Nope.  People who had died outperformed.  The lesson we can learn?  Leave your account the hell alone.  Of course invest in index funds because ERs are the ONLY thing you can know in advance.  Lowest ER wins.

arebelspy

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Re: Index fund "bubble" about to burst?
« Reply #29 on: November 24, 2016, 05:31:49 PM »


People, remember concentration in the top stocks is an effect, not a cause.

Those stocks have a high value because the market believes they will earn the lions share of profits.

Excellent point.
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MustacheAndaHalf

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Re: Index fund "bubble" about to burst?
« Reply #30 on: November 24, 2016, 06:51:02 PM »
The fundamental problem with index funds is market cap weighting. Flows out of bond funds, and actively managed funds into S&P 500 based index funds that are concentrated into the largest companies.

The S&P 500 index by percentage:
10% allocation to  3 companies - AAPL, GOOG, MSFT
20% allocation to 10 companies - BRK, XOM, AMZN, JNJ, FB, GE, JPM
50% allocation to 50 companies

If 50% of the money flowing into index funds is used to buy shares in only 50 companies (32% by market cap are in the tech sector), what do you think the price of those shares are going to do? Index investors are not nearly as diversified as they think and it will come back to bite them sometime in the future. To see what you, as an index investor are really buying right now, take a look at the holdings of the etf XLG which holds the top 50 largest S&P components.

The funny thing is we had almost this exact same situation with the Nifty 50 back in the 1960's. It didn't turn out too well.
I think your numbers are out of date.
1. You list "GOOG" which no longer exists under that name, it's now called "Alphabet".
2. You list 10% for the top 3 stocks in the S&P 500.  Vanguard shows 8.3% while morningstar shows 7.7%.
3. You claim 32% tech sector for the top 50 based on "XLG" ETF, when morningstar shows 27.5%.

Your key point seems to be that individual company risk is a problem for the S&P 500 just like it was for the Nifty Fifty.  But people bought single companies in the 1960s, so a 1/3rd decline in value meant losing -33% of assets.  If even Apple takes a 1/3rd hit in it's value, that would reduce it from 3.3% of the S&P 500 to 2.2% of the index, a loss of -1.1%.  So what is the problem that you claim is similar to the Nifty Fifty era?

When you buy an S&P 500 index fund or ETF, you get 19.3% exposure to the tech sector.  I don't understand how the exposure of just the top 50 is meaningful to an investor who holds all of the S&P 500 stocks.
« Last Edit: November 24, 2016, 06:53:02 PM by MustacheAndaHalf »

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Re: Index fund "bubble" about to burst?
« Reply #31 on: November 24, 2016, 07:55:50 PM »
the higher the schiller PE ratio, the lower average returns for the next decade.

No doubt. 

But the thing is: you have to have somewhere to stick the money.  Whether that's gold, cash, commodities, bonds, stocks, real estate, whatever...

The market may have lower than average returns going forward in the short term, but it still may be better than everything else.  And without a crystal ball, we just don't know.

Given that everything ELSE looks overvalued, too.  The bond market is at historically ridiculously low rates, so has not much elsewhere to go but up.  Real estate has been driven up over the last 4-5 years.

Quantitative easing has put the world awash in funds searching for yield, driving all assets up, and lowering the forward looking expected returns on everything.

Thus you see so many companies hoarding cash (see Berkshire, or Apple, for examples).  And you see TONS of companies doing stock buybacks.

Quote
If I had extra cash and found an alternative investment vehicle more likely to produce better returns over the next decade

There's the rub.  The market IS overvalued. Yet it still seems like the best place to put your investments, IMO.
 Because it's hard to find anything that isn't overvalued, without chasing yield and ending up way riskier than you should, giving you quite poor risk adjusted returns (with things like peer to peer lending, or crowd sourced real estate investment sites).

So I vote: stay the course.

YMMV, of course.  :)

Good post.

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Re: Index fund "bubble" about to burst?
« Reply #32 on: November 24, 2016, 10:03:21 PM »
The fundamental problem with index funds is market cap weighting. Flows out of bond funds, and actively managed funds into S&P 500 based index funds that are concentrated into the largest companies.

The S&P 500 index by percentage:
10% allocation to  3 companies - AAPL, GOOG, MSFT
20% allocation to 10 companies - BRK, XOM, AMZN, JNJ, FB, GE, JPM
50% allocation to 50 companies

If 50% of the money flowing into index funds is used to buy shares in only 50 companies (32% by market cap are in the tech sector), what do you think the price of those shares are going to do? Index investors are not nearly as diversified as they think and it will come back to bite them sometime in the future. To see what you, as an index investor are really buying right now, take a look at the holdings of the etf XLG which holds the top 50 largest S&P components.

The funny thing is we had almost this exact same situation with the Nifty 50 back in the 1960's. It didn't turn out too well.
I think your numbers are out of date.
1. You list "GOOG" which no longer exists under that name, it's now called "Alphabet".
2. You list 10% for the top 3 stocks in the S&P 500.  Vanguard shows 8.3% while morningstar shows 7.7%.
3. You claim 32% tech sector for the top 50 based on "XLG" ETF, when morningstar shows 27.5%.

Your key point seems to be that individual company risk is a problem for the S&P 500 just like it was for the Nifty Fifty.  But people bought single companies in the 1960s, so a 1/3rd decline in value meant losing -33% of assets.  If even Apple takes a 1/3rd hit in it's value, that would reduce it from 3.3% of the S&P 500 to 2.2% of the index, a loss of -1.1%.  So what is the problem that you claim is similar to the Nifty Fifty era?

When you buy an S&P 500 index fund or ETF, you get 19.3% exposure to the tech sector.  I don't understand how the exposure of just the top 50 is meaningful to an investor who holds all of the S&P 500 stocks.

The point of the post is the concentration risk with cap weighted indices. Your right my info came from August. Since then AAPL, MSFT, Googl/goog (which is still alphabet's ticket), and xom make up 10.4% of the index. The largest 50 companies make up 50% of the S&P so when people thing they are "buying the market" that's not really that diversified.

When money does in to index funds at the rates it has been the past few years, these companies at the top get overbought and process pushed higher. They are being bought for the sake of being big, not on fundamentals.

Well said (above).

People, remember concentration in the top stocks is an effect, not a cause.

Those stocks have a high value because the market believes they will earn the lions share of profits. (At some point in the future, maybe)

We live in a world where for certain industries monopoly-like powers can exist, and in these capital intensive areas a competitive advantage may be sustainable.  In these areas it requires market strength and capital to compete or match the advantages.  Walmart and Costco spent a lot of time building stores and training their customers.  This is worth something.  GE spent a lot of intellectual capital to build their surgical equipment products, supply chain, relationships with hospitals, etc.  The market recognizes these assets and hence a few companies are worth a lot.



DavidAnnArbor

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Re: Index fund "bubble" about to burst?
« Reply #33 on: November 25, 2016, 09:01:07 AM »
That's why it's good to have a dose of the international index funds, to avoid the Japan boom/bust scenario affecting your portfolio.

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Re: Index fund "bubble" about to burst?
« Reply #34 on: November 25, 2016, 02:57:57 PM »
As anyone ever seen any evidence of this? (quote from original post article):
Quote
But actively-managed funds tend to outperform passive offerings when the market goes down

The two funds mentioned in the article seem to have underperformed (by a significant margin) in last crisis, but got me curious.

2008 returns according to Morningstar:
John Rogers / Ariel Fund (-48.25)
Robert Bacarella / Monetta Fund (-47.54)
S&P500 (-37.00)

source:
http://performance.morningstar.com/fund/performance-return.action?t=ARGFX&region=usa&culture=en-US
http://performance.morningstar.com/fund/performance-return.action?t=MONTX&region=usa&culture=en-US

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Re: Index fund "bubble" about to burst?
« Reply #35 on: November 25, 2016, 05:23:36 PM »
As anyone ever seen any evidence of this? (quote from original post article):
Quote
But actively-managed funds tend to outperform passive offerings when the market goes down

The two funds mentioned in the article seem to have underperformed (by a significant margin) in last crisis, but got me curious.

2008 returns according to Morningstar:
John Rogers / Ariel Fund (-48.25)
Robert Bacarella / Monetta Fund (-47.54)
S&P500 (-37.00)

source:
http://performance.morningstar.com/fund/performance-return.action?t=ARGFX&region=usa&culture=en-US
http://performance.morningstar.com/fund/performance-return.action?t=MONTX&region=usa&culture=en-US

I'm going to go out on a limb and guess -- and correct the quote:
Quote
But some actively-managed funds tend to outperform some passive offerings when the market goes down

I'll also say that the qualifier "tend to" is a cop out.  It is a floating, fuzzy generalization.  If they had actually done research and had real evidence they'd quantify it with something like "X% of actively managed funds have outperformed..."

arebelspy

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Re: Index fund "bubble" about to burst?
« Reply #36 on: November 25, 2016, 05:58:24 PM »
Those stocks have a high value because the market believes they will earn the lions share of profits.

(At some point in the future, maybe)

One way to look at it is that the value today is the NPV of the projected future cash flows.  So not just "some point" in the future, all points in the future, discounted to today.  :)
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aceyou

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Re: Index fund "bubble" about to burst?
« Reply #37 on: November 25, 2016, 09:39:11 PM »
the higher the schiller PE ratio, the lower average returns for the next decade.

No doubt. 

But the thing is: you have to have somewhere to stick the money.  Whether that's gold, cash, commodities, bonds, stocks, real estate, whatever...

The market may have lower than average returns going forward in the short term, but it still may be better than everything else.  And without a crystal ball, we just don't know.

Given that everything ELSE looks overvalued, too.  The bond market is at historically ridiculously low rates, so has not much elsewhere to go but up.  Real estate has been driven up over the last 4-5 years.

Quantitative easing has put the world awash in funds searching for yield, driving all assets up, and lowering the forward looking expected returns on everything.

Thus you see so many companies hoarding cash (see Berkshire, or Apple, for examples).  And you see TONS of companies doing stock buybacks.

Quote
If I had extra cash and found an alternative investment vehicle more likely to produce better returns over the next decade

There's the rub.  The market IS overvalued. Yet it still seems like the best place to put your investments, IMO.
 Because it's hard to find anything that isn't overvalued, without chasing yield and ending up way riskier than you should, giving you quite poor risk adjusted returns (with things like peer to peer lending, or crowd sourced real estate investment sites).

So I vote: stay the course.

YMMV, of course.  :)

+1

This kind of makes me think of all the time that people in the sports media call to have pro or college coaches fired after a bad year or two, but they don't consider a really key consideration...you only go through the ugly process of firing if you are reasonably sure you can replace them with a better candidate.  Otherwise, you are now paying two contracts and perhaps losing even more.  So yeah, even if you feel the stock market has less potential over the coming decade or so, what action do you want to take?  Do we "fire" the index fund for gold, or bonds, or REIT's, actively managed funds, cash, etc? 


DavidAnnArbor

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Re: Index fund "bubble" about to burst?
« Reply #38 on: November 30, 2016, 04:56:50 PM »
According to a tweet from Paul Krugman, the rally in stock indices since the election is largely a rally for Wall street financial firms.

https://twitter.com/paulkrugman/status/803334979874914311


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Re: Index fund "bubble" about to burst?
« Reply #39 on: November 30, 2016, 06:35:27 PM »
This talk about an index fund bubble probably got started by an active manager. Is money going to start flowing OUT of my S&P 500 index fund in favor of actively managed funds. I don't believe it. Not as long as index funds keep outperforming managers year after year.

The markets are actually more efficient because of index funds. One more reason to stick with index funds instead of active managers.

If you believe the hysteria then just buy a total stock market index fund and not worry about it. It's a zero sum game therefore the total stock market should not be affected.

No, they're not. They're less efficient.

Index funds aren't rational market players.

The fundamental problem with index funds is market cap weighting. Flows out of bond funds, and actively managed funds into S&P 500 based index funds that are concentrated into the largest companies.

The S&P 500 index by percentage:
10% allocation to  3 companies - AAPL, GOOG, MSFT
20% allocation to 10 companies - BRK, XOM, AMZN, JNJ, FB, GE, JPM
50% allocation to 50 companies

If 50% of the money flowing into index funds is used to buy shares in only 50 companies (32% by market cap are in the tech sector), what do you think the price of those shares are going to do? Index investors are not nearly as diversified as they think and it will come back to bite them sometime in the future. To see what you, as an index investor are really buying right now, take a look at the holdings of the etf XLG which holds the top 50 largest S&P components.

The funny thing is we had almost this exact same situation with the Nifty 50 back in the 1960's. It didn't turn out too well.

^^ Dudes right on. Look at the historical value of XOM as an example. It's highly inflated even though it might not seem so. Eventually the Index bubble will burst, as do all bubbles. Because of market cap weighting, you're all not as diversified as the funds claim to be.

You'll probably be fine though, long term.

There is no doubt that an active manager can beat the index.  The vanguard studies show that, however it's difficult to do it over the long term.

If you want to try to be that person, and spend the time to make that happen, and maybe get lucky, great.  For me index funds gave me a way to capture the majority of the gains, consistently, with zero effort other than clicking a few buttons, saving time and stress.

For those not convinced, try doing a small amount of money in active management or individual stocks.  See how you do and if you have what it takes over a few years.

Of course active management can beat an index. An index is just average. The returns of active management though are weighed down by the plethora of active managers that shouldn't be active managing.

If you want to take a lot of the homework out and avoid index funds at the same time, out of the like 20,000+ stocks there's probably less than 100 that should be considered for your set and forget portfolio.

Personally don't hold any index funds or mutual funds. Long term is being constructed out of companies that have a high probability of being here in 100+ years and continuing to increase earnings.

** Most active managers that can beat the index likely run hedge funds, mutual funds are for losers. Those active managers running those hedge funds also likely tend to shy away from the spotlight (it's not a great buy if everyone thinks it is) and they limit the size of their fund (there comes a point when a fund is too big to get the above average returns, you don't use a club when the situation calls for a scalpel).
« Last Edit: November 30, 2016, 06:39:22 PM by LordSquidworth »

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Re: Index fund "bubble" about to burst?
« Reply #40 on: November 30, 2016, 08:23:15 PM »
An index is not 'average', it's the market return.  The competitive pricing of the stock market is accepted by an index fund - all stocks are bought in proportion to their market cap.  Active managers can only beat that return by out picking the market consistently.

And in practice, indexing beats the averages frequently.  Between research costs that don't produce results, buying and selling that triggers needless costs and taxes, the active funds perform poorly over time.
https://us.spindices.com/documents/spiva/spiva-us-mid-year-2016.pdf

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Re: Index fund "bubble" about to burst?
« Reply #41 on: December 01, 2016, 06:54:10 AM »
An index is not 'average', it's the market return.  The competitive pricing of the stock market is accepted by an index fund - all stocks are bought in proportion to their market cap.  Active managers can only beat that return by out picking the market consistently.

And in practice, indexing beats the averages frequently.  Between research costs that don't produce results, buying and selling that triggers needless costs and taxes, the active funds perform poorly over time.
https://us.spindices.com/documents/spiva/spiva-us-mid-year-2016.pdf

I agree with your conclusion.

People seem to think that there are ONLY index funds and active funds using that index.  That's not correct.  There's Joe Blow day trader who happens to buy Apple today and sell it off 2 weeks from now.  There's the institution handling a huge pension fund that decides to dump $1B of Berkshire Hathaway for whatever reasons.  There are the funds and indexes that share company stock in them.  So to say that there's some total number, some average and thus all active funds must split +/- to equal the rest isn't the case.  It is possible for every single active fund to underperform the index.  It's also possible for every single active fund to overperform the index.  This would be true even if the active funds only bought the funds inside the index (which they don't) because they can buy low and sell high all day long, winning on every transaction.....or losing on every transaction.

Just remember (as mentioned above) that only costs can be predicted.  Nothing else can.

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Re: Index fund "bubble" about to burst?
« Reply #42 on: December 01, 2016, 08:42:24 AM »
"The next 10 years will be a great period for the stock picker."  <-- They don't know this!  (And what does that even mean?!  All individual stocks are going to do well independently of the indices?)

"...all economic indicators are now reflecting that we are in the late stage of the rally"  <-- They don't know this!

"...while active investors and traders will see many excellent entry points for their buy orders."   <-- THEY DON'T KNOW THIS!!

If writers, fund managers, and advisors were held fully and financially accountable for their statements, it'd be a whole other ballgame.  But alas, little has changed from 50 years ago when people used to yell, "Buy pork bellies!," on exchange floors.


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Re: Index fund "bubble" about to burst?
« Reply #43 on: December 01, 2016, 01:53:17 PM »
Personally don't hold any index funds or mutual funds. Long term is being constructed out of companies that have a high probability of being here in 100+ years and continuing to increase earnings.

I love this comment. You have the ability to predict the next 100+ years. Well done sir.

** Most active managers that can beat the index likely run hedge funds, mutual funds are for losers. Those active managers running those hedge funds also likely tend to shy away from the spotlight (it's not a great buy if everyone thinks it is) and they limit the size of their fund (there comes a point when a fund is too big to get the above average returns, you don't use a club when the situation calls for a scalpel).

Another gold moment. My FIL managed one of these funds. It went bust.

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Re: Index fund "bubble" about to burst?
« Reply #44 on: December 01, 2016, 10:13:41 PM »
I don't think it's true that active funds offer downside protection.

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Re: Index fund &quot;bubble&quot; about to burst?
« Reply #45 on: December 02, 2016, 12:10:50 AM »
I don't think it's true that active funds offer downside protection.
Agreed.

If anything, you're risking selling low even more, because now both you AND the manager have to be able to ride it out.

Without a manager, you need to be able to ride it out. With one, you STILL have to not panic sell, plus have to have them not make bad moves.
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Re: Index fund "bubble" about to burst?
« Reply #46 on: December 02, 2016, 08:06:21 AM »
A ton of money is switching from active to passive/index funds, most of it going to S&P500 and total market funds, which means the largest 50 or so stocks get 50% of this money.

Is this causing market distortions? Are these 50 or so largest stocks approaching worrying over-valuation?

“The tidal wave of capital allocation to passive has created valuation distortions that are beneficial for disciplined, intelligent value investors.”
- Mason Hawkins, Longleaf 3Q16 Partners Webcast Thursday, November 17, 2016

He would say that, wouldn't he? But that doesn't mean he's wrong.

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Re: Index fund "bubble" about to burst?
« Reply #47 on: December 02, 2016, 08:40:57 AM »
A ton of money is switching from active to passive/index funds, most of it going to S&P500 and total market funds, which means the largest 50 or so stocks get 50% of this money.

Is this causing market distortions? Are these 50 or so largest stocks approaching worrying over-valuation?

“The tidal wave of capital allocation to passive has created valuation distortions that are beneficial for disciplined, intelligent value investors.”
- Mason Hawkins, Longleaf 3Q16 Partners Webcast Thursday, November 17, 2016

He would say that, wouldn't he? But that doesn't mean he's wrong.

Isn't that true regardless of whether there are index funds or not?  What I mean is: wasn't there already a flow to the Fortune 500 (and to a lesser degree the US market) just by the fact that it was labeled as "one of the top 500"?

I can't say I honestly know the answer to my own question... I'm mostly asking as devil's advocate.

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Re: Index fund &quot;bubble&quot; about to burst?
« Reply #48 on: December 02, 2016, 08:51:29 AM »
A ton of money is switching from active to passive/index funds, most of it going to S&P500 and total market funds, which means the largest 50 or so stocks get 50% of this money.

Is this causing market distortions? Are these 50 or so largest stocks approaching worrying over-valuation?

“The tidal wave of capital allocation to passive has created valuation distortions that are beneficial for disciplined, intelligent value investors.”
- Mason Hawkins, Longleaf 3Q16 Partners Webcast Thursday, November 17, 2016

He would say that, wouldn't he? But that doesn't mean he's wrong.

Isn't that true regardless of whether there are index funds or not?  What I mean is: wasn't there already a flow to the Fortune 500 (and to a lesser degree the US market) just by the fact that it was labeled as "one of the top 500"?

I can't say I honestly know the answer to my own question... I'm mostly asking as devil's advocate.
If it was, doesn't more and more use of index funds exacerbate the problem?
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Re: Index fund &quot;bubble&quot; about to burst?
« Reply #49 on: December 02, 2016, 10:12:47 AM »
A ton of money is switching from active to passive/index funds, most of it going to S&P500 and total market funds, which means the largest 50 or so stocks get 50% of this money.

Is this causing market distortions? Are these 50 or so largest stocks approaching worrying over-valuation?

“The tidal wave of capital allocation to passive has created valuation distortions that are beneficial for disciplined, intelligent value investors.”
- Mason Hawkins, Longleaf 3Q16 Partners Webcast Thursday, November 17, 2016

He would say that, wouldn't he? But that doesn't mean he's wrong.

Isn't that true regardless of whether there are index funds or not?  What I mean is: wasn't there already a flow to the Fortune 500 (and to a lesser degree the US market) just by the fact that it was labeled as "one of the top 500"?

I can't say I honestly know the answer to my own question... I'm mostly asking as devil's advocate.
If it was, doesn't more and more use of index funds exacerbate the problem?

Possibly.

I was also thinking the effect could just be caused by more people being in the market.  Forty years or more ago... only a tiny slice of the population invested in stocks.  In current days, everyone from the CEO down to the janitor has some slice of their money in the market.