Author Topic: Index Funds or Pick Your Own-Some Strong Sentiments made!  (Read 2901 times)

soccerluvof4

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Index Funds or Pick Your Own-Some Strong Sentiments made!
« on: January 28, 2014, 12:42:27 PM »
I just read this from a investment sight I pay to follow so hence I cant share the persons name or source but anyhow a good read and what say you I ask????


I saw a tweet Monday from Vanguard: 20 years ago, index funds made up 4% of all fund assets. Now, they are 34% of fund assets.

Let's deconstruct this for a moment. To be fair, this number includes all passive indexing such as sector and country ETFs. But it's pretty remarkable to think that over one-third of fund investors are just punting on stock picking and putting money in an index blob instead.

Let's consider the extreme scenario where everyone invests in index funds. What does that world look like? It would mean that the stock market is perfectly correlated. But that would be dumb, because some companies make more money than other companies and grow at different rates. The market wouldn't be efficient. In fact, it would be very inefficient. The market would be valuing about half of companies too richly and half too cheaply.

I believe sometimes that indexing is reaching absurd levels in the stock market. The whole point of this exercise is to -- never mind, I am not going to get into a discussion about what the point of the stock market is. But it is not some kind of magic asset class that returns 8% to 10% a year. It is not a situation where all you have to do is plop some money in an index fund and forget about it, like Jeremy Siegel and Jack Bogle tell you to do.

Index funds are fine, if you really are willing to lock up the money and throw away the key. But just in 2008, we had a 60% drawdown, and who can tolerate a 60% drawdown? Professional money management might not beat the index most of the time. But if 2008 proved anything, it is that indexing is a poor long-term strategy. Most index fund investors vomited on the lows and were forced to buy back in at higher levels.

I am a former ETF trader, a fairly well-known one. Just today, I am in Florida for the Inside ETFs conference put on by the folks at ETF.com (formerly Index Universe). I use ETFs all the time. They make sense for a top-down guy like me. Principally, I use them when I have a macro view on a sector but I don't know enough about the space to pick stocks.

Sometimes I use them to put money to work while I research individual stocks. But I don't dollar-cost average, writing checks to index funds periodically. Because if there is one thing that everyone in finance should understand, it is that anything can go to zero. You would not have done well to dollar-cost average Iceland. Entire countries can go to zero. For example, back when I was in business school 15 years ago, the U.S. was considered to be the risk-free rate, beyond AAA. Not likely to default. Now, people aren't as sure.

There are no sure things in this business.

Let's return to my original point. All of the money going into index funds creates opportunities for stock pickers like you and me. Index investing when taken to extreme levels actually forces stock prices away from their fair value. Some literature I read many years ago estimated that the average stock in the S&P 500 was overvalued to the tune of 5%, because of indexing. It is probably higher today. I'm not saying that index funds are bad, only that they create distortions. But these are good distortions, because we can make money off of them.

It's hard to believe, but in the age of ETFs and killer trading robots, picking stocks might be easier than ever. The algorithms are increasing short-term efficiency but decreasing it in the long term. Combine that with the distortions caused by indexing, and this game is probably easier than it has been in years. There are no excuses.

DB

Eric

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Re: Index Funds or Pick Your Own-Some Strong Sentiments made!
« Reply #1 on: January 28, 2014, 12:55:12 PM »
Trader thinks he can beat the market.  I'm shocked, just shocked!!

http://jlcollinsnh.com/2013/02/05/stocks-part-xv-index-funds-are-really-just-for-lazy-people-right/

soccerluvof4

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Re: Index Funds or Pick Your Own-Some Strong Sentiments made!
« Reply #2 on: January 28, 2014, 12:58:13 PM »
Eric,

I was just shocked by the increase in index funds but I too agree with what your saying.

Richard3

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Re: Index Funds or Pick Your Own-Some Strong Sentiments made!
« Reply #3 on: January 28, 2014, 01:41:41 PM »
It's not that surprising, killer trading robots get mr Market all excited and this makes his mood swings worse. I blame all the Doctor Who he watched in the 70s. :)

Cyrano

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Re: Index Funds or Pick Your Own-Some Strong Sentiments made!
« Reply #4 on: January 28, 2014, 06:14:43 PM »
We can worry about the absurd endpoint where no business analysts are left when index funds hold 90% of shares outstanding.

judgemebymyusername

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Re: Index Funds or Pick Your Own-Some Strong Sentiments made!
« Reply #5 on: January 28, 2014, 07:01:53 PM »
"But if 2008 proved anything, it is that indexing is a poor long-term strategy. Most index fund investors vomited on the lows and were forced to buy back in at higher levels."

That's a problem with the investors, not the index funds.

Your questions are answered in this book http://www.amazon.com/Common-Sense-Mutual-Funds-Anniversary/dp/0470138130/ref=sr_1_2?s=books&ie=UTF8&qid=1390960838&sr=1-2&keywords=bogle+on+mutual+funds

MMM covers your exact question about what would happen if everyone invested in index funds, but unfortunately I can't find the blog post because the search is broken on his page.