Author Topic: Interesting Article, What's your opinion on Index Funds?  (Read 3104 times)

ThatGuy

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Interesting Article, What's your opinion on Index Funds?
« on: June 25, 2018, 09:45:55 PM »
All of my investment money is in index funds and most would consider my investments very aggressive.  Having said that this article talks about something I've been thinking about, although I didn't think of the detail they did.  Do you think they make a good point?

https://www.fool.com/investing/2018/06/24/the-hidden-index-bubble.aspx


DreamFIRE

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #1 on: June 25, 2018, 10:01:49 PM »

Mehhh...   this has come up before.

e34bb098

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #2 on: June 25, 2018, 10:03:19 PM »
Itís self-correcting. Index investing acknowledges that some genius investor(s) can beat the market. It just says that the genius probably ainít you.

If a particular stock is undervalued then genius investors will pour money into it and then make money. This will cause its stock price to rise which will increase its market cap. Then when you buy your index fund with part of your next pay check you will be buying in proportion to the companyís true value. And the index funds youíve already bought rise accordingly.

So it is all right. Indexers will never be in the 99th percentile. But if you can live with being in the 80th percentile, year after year, then youíll be all right.

Telecaster

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #3 on: June 25, 2018, 10:17:26 PM »

So it is all right. Indexers will never be in the 99th percentile. But if you can live with being in the 80th percentile, year after year, then youíll be all right.

Indexers--if you just hold the index--are in the 95th percentile.  I can live with that.

re: the article.  There is a point or two in there worth considering but not fretting over.  Indexing by its nature is a large-cap strategy.  That's not terrible, but it is certainly worth considering stiring in a bit of mid-cap and a dash of small-cap as well.  See this thread for example:

https://forum.mrmoneymustache.com/investor-alley/you-can-beat-the-market-non-cap-weighted-investments/

MustacheAndaHalf

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #4 on: June 26, 2018, 07:56:09 AM »
(from the article)
> "The arguments for passive investing have been well-documented"

No, the evidence for passive indexing is well documented.  The facts, not arguments.  SPIVA has an excellent methodology for tracking performance, and in their data the S&P 500 beats 90% of large cap actively managed funds.
https://us.spindices.com/documents/spiva/spiva-us-year-end-2017.pdf


> "Research has shown that the repercussions of such a profound shift could be dramatic"

What research?  This is the key point of the article, and no follow up is provided on this claim.


> "the big are definitely getting bigger."

The claim is that S&P 500 indexing causes this.  But passive investment is proportional to size.  When money flows into an S&P 500 index fund, the 500th largest company receives the same percentage boost as the largest company.

Actually my experiment in another thread has a better explanation for this than they do:  tech stocks.  The Vanguard Information Technology ETF (VGT) is the best performing ETF in all of Vanguard over the past year.  A better explanation for the big getting bigger is that already big tech companies are getting even bigger.


> "As money flows into passive index funds, it trickles down to the largest companies first -- companies like Apple, Microsoft, Amazon, and Facebook."

When you see "Apple, Microsoft, Amazon and Facebook"... does that sound more like large companies in the S&P 500, or more like tech companies?  Also, as I understand it, index funds buy companies at the same time - they do not buy "the largest companies first".


I guess I could go on picking apart the article, but my main point is this: given the chance to use historical performance to support their idea, they didn't.  SPIVA's data shows that the S&P 500 index continues to beat large cap funds, and the longer the time frame the higher the percentage of funds it beats.
https://us.spindices.com/documents/spiva/spiva-us-year-end-2017.pdf

Xlar

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #5 on: June 26, 2018, 09:22:41 AM »
(from the article)
> "The arguments for passive investing have been well-documented"

No, the evidence for passive indexing is well documented.  The facts, not arguments.  SPIVA has an excellent methodology for tracking performance, and in their data the S&P 500 beats 90% of large cap actively managed funds.
https://us.spindices.com/documents/spiva/spiva-us-year-end-2017.pdf


> "Research has shown that the repercussions of such a profound shift could be dramatic"

What research?  This is the key point of the article, and no follow up is provided on this claim.


> "the big are definitely getting bigger."

The claim is that S&P 500 indexing causes this.  But passive investment is proportional to size.  When money flows into an S&P 500 index fund, the 500th largest company receives the same percentage boost as the largest company.

Actually my experiment in another thread has a better explanation for this than they do:  tech stocks.  The Vanguard Information Technology ETF (VGT) is the best performing ETF in all of Vanguard over the past year.  A better explanation for the big getting bigger is that already big tech companies are getting even bigger.


> "As money flows into passive index funds, it trickles down to the largest companies first -- companies like Apple, Microsoft, Amazon, and Facebook."

When you see "Apple, Microsoft, Amazon and Facebook"... does that sound more like large companies in the S&P 500, or more like tech companies?  Also, as I understand it, index funds buy companies at the same time - they do not buy "the largest companies first".


I guess I could go on picking apart the article, but my main point is this: given the chance to use historical performance to support their idea, they didn't.  SPIVA's data shows that the S&P 500 index continues to beat large cap funds, and the longer the time frame the higher the percentage of funds it beats.
https://us.spindices.com/documents/spiva/spiva-us-year-end-2017.pdf

This second point is key. The article builds their entire argument on this premise but provides no references. You can claim anything you want but unless you back it up it is meaningless.

Also the third point here shows a fundamental lack of understanding on how index funds work (on the part of the article). This completely undermines any trust that I have in accepting their premise. If they cannot even get the basics right...

Seems like another click-bait article from fool.com trying to get people to buy their actively managed funds.

Telecaster

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #6 on: June 26, 2018, 09:33:17 AM »

The claim is that S&P 500 indexing causes this.  But passive investment is proportional to size.  When money flows into an S&P 500 index fund, the 500th largest company receives the same percentage boost as the largest company.


Not quite--although I might not be understanding you correctly.   Because of the cap weight, about 20% of each dollar goes to the top 20 largest stocks.   The bottom 20 get more like 0.1%.   So they get they same percentage boost by cap weight, but not by dollar amount. 

That does preserve the cap weight (which I think is what you are saying), but the bigger stocks do indeed have more dollars flowing into them.  So the big get bigger. 

SeattleCPA

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #7 on: June 26, 2018, 09:14:38 PM »

So it is all right. Indexers will never be in the 99th percentile. But if you can live with being in the 80th percentile, year after year, then youíll be all right.

Indexers--if you just hold the index--are in the 95th percentile.  I can live with that.

re: the article.  There is a point or two in there worth considering but not fretting over.  Indexing by its nature is a large-cap strategy.  That's not terrible, but it is certainly worth considering stiring in a bit of mid-cap and a dash of small-cap as well.  See this thread for example:

https://forum.mrmoneymustache.com/investor-alley/you-can-beat-the-market-non-cap-weighted-investments/

+1

ThatGuy

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #8 on: June 26, 2018, 10:47:51 PM »
I did consider the source and the fact that index investors don't buy their newsletters etc.  I work for the post office so my retirement has five choices. I have 60% in the C fund which tracks the S&P 500, and 40% in the S fund which I believe follows the Russell 2000.  My IRA is invested 100% in IJR which is a small cap index fund.  Like I said, I am invested aggressively.  When the market hit bottom in 2009 my account had fallen 50% and it didn't bother me.  I was curious what others thought of the article because it was something that I had actually thought of and it surprised me lol.
« Last Edit: June 26, 2018, 10:52:04 PM by ThatGuy »

MustacheAndaHalf

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #9 on: June 27, 2018, 05:57:16 AM »

The claim is that S&P 500 indexing causes this.  But passive investment is proportional to size.  When money flows into an S&P 500 index fund, the 500th largest company receives the same percentage boost as the largest company.


Not quite--although I might not be understanding you correctly.   Because of the cap weight, about 20% of each dollar goes to the top 20 largest stocks.   The bottom 20 get more like 0.1%.   So they get they same percentage boost by cap weight, but not by dollar amount. 

That does preserve the cap weight (which I think is what you are saying), but the bigger stocks do indeed have more dollars flowing into them.  So the big get bigger.

The article's point was that individual big companies benefit disproportionately, meaning the perspective is from the individual company (as I understood it).  I'm saying if an S&P 500 mutual fund with a billion in assets suddenly gets $50 million in cash to invest, it invests that money proportional to market cap.  Relative to each company, each company sees +5% investment from this specific S&P 500 index fund.  If Apple Inc has a 3.93% weight before the cash is invested, it will also have a 3.93% weight after the cash is invested.  The cash will be invested relative to market cap of each individual company.

Large companies will get "more dollars", but the exact same percentage of investment.  Apple Inc will see the S&P 500 fund's holdings grow +5%, but so will the smallest company in the S&P 500 see the fund's holdings grow by +5% of their stock.

No company within the S&P 500 gets a relative advantage from the purchases made by an S&P 500 index fund, because all purchases are proportional to market cap ('company size').

marty998

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Re: Interesting Article, What's your opinion on Index Funds?
« Reply #10 on: June 29, 2018, 04:25:07 AM »

The claim is that S&P 500 indexing causes this.  But passive investment is proportional to size.  When money flows into an S&P 500 index fund, the 500th largest company receives the same percentage boost as the largest company.


Not quite--although I might not be understanding you correctly.   Because of the cap weight, about 20% of each dollar goes to the top 20 largest stocks.   The bottom 20 get more like 0.1%.   So they get they same percentage boost by cap weight, but not by dollar amount. 

That does preserve the cap weight (which I think is what you are saying), but the bigger stocks do indeed have more dollars flowing into them.  So the big get bigger.

The article's point was that individual big companies benefit disproportionately, meaning the perspective is from the individual company (as I understood it).  I'm saying if an S&P 500 mutual fund with a billion in assets suddenly gets $50 million in cash to invest, it invests that money proportional to market cap.  Relative to each company, each company sees +5% investment from this specific S&P 500 index fund.  If Apple Inc has a 3.93% weight before the cash is invested, it will also have a 3.93% weight after the cash is invested.  The cash will be invested relative to market cap of each individual company.

Large companies will get "more dollars", but the exact same percentage of investment.  Apple Inc will see the S&P 500 fund's holdings grow +5%, but so will the smallest company in the S&P 500 see the fund's holdings grow by +5% of their stock.

No company within the S&P 500 gets a relative advantage from the purchases made by an S&P 500 index fund, because all purchases are proportional to market cap ('company size').

Too add to this, the index fund still needs to find a seller in order to purchase the stock. So at the point of purchase, the marginal prices might go up a bit, but they may also go down a bit if an index fund is selling too.

All in all, it's probably much of a muchness.