Author Topic: Looking for good perspective/articles on index funds messing with the market  (Read 1843 times)

RusticBohemian

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Over the last decade I've heard a refrain repeated that seems to be coming up more and more these days - the mass move to index investing is messing with the stock market, raising prices in a way disconnected from the underlying value of the companies the stocks represent.

This, it's often argued, is used as part of a warning against index investing. Often it's used to push dividend investing, or something else.

I haven't heard MMM or Jim Collins weigh in on these topics (please link me if I'm mistaken). Are there any other good analyses I should be checking out?

vand

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It's really just a theoretical problem at this point. There is still more than enough active investing going on to perform price discovery.

My own theory is that if and when too many people have moved over to indexing then, yes, they will get the market return, but a) that market return will generally be lower than we have seen in the past, and b) it will also be much easier to beat the market... and the issue becomes self-correcting. Generally with markets, if too many people do one thing that "works" it then eventually stops working.  It may be that in a world of too many indexers, just being able to identify good cheap companies from bad expensive ones may be enough of an edge to beat the market overall (provided you hold for a long enough period) which will entice people will move back to active investing, and so the market itself finds the right balance between indexers and active investors.

Of course, the data at this point is always backward looking. We know a dismally small number of active funds beat the market in the last 10 years, but going forward as this has enticed more people to indexing, it remains to be seen how that number is continually changing. I don't expect in a world where most people index that a plurality of funds can beat or match or the market, but I do expect that it would be a higher number than we see currently.

The saying with passive investing is that "dumb money stops becoming dumb when it recognises its own limitations". But I would add that it at some point it probably becomes dumb money thinking its being clever but is actually back to being dumb money when everyone is doing it.
« Last Edit: June 14, 2019, 04:31:46 AM by vand »

Blueberries

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The reason this has become an issue in the last 10 years is because indexing has been working (higher returns).  The higher returns won't always be the case.  In my opinion, which isn't worth much, we're due for a period of lower returns where the indexes move largely sideways.  It's from that type of action that you'll see future explosive growth.  We've had periods of years (over a decade) of sideways movement where indexes weren't making much progress because the market traded in a sideways range.  If that continues, you might see less indexing and more active investing. 

FWIW, we've been moving sideways since August 2018. 

Edited to add - Indexing in a retirement fund is still the best option for most people.

Over the last decade I've heard a refrain repeated that seems to be coming up more and more these days - the mass move to index investing is messing with the stock market, raising prices in a way disconnected from the underlying value of the companies the stocks represent.

This, it's often argued, is used as part of a warning against index investing. Often it's used to push dividend investing, or something else.

I haven't heard MMM or Jim Collins weigh in on these topics (please link me if I'm mistaken). Are there any other good analyses I should be checking out?

I would not treat MMM as an authority on such things.  I don't know enough about Collins to have an opinion.

Read a couple articles in which Bogle sounded off on this:

http://money.com/money/5468239/jack-bogle-index-funds-problem/

https://www.marketwatch.com/story/john-bogle-has-a-warning-for-index-fund-investors-2017-06-01

« Last Edit: June 14, 2019, 07:19:57 AM by Blueberries »

bacchi

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https://www.marketwatch.com/story/john-bogle-has-a-warning-for-index-fund-investors-2017-06-01

Ha. That article left off the most important part of what Bogle said that day.

“Now, what are the chances of everybody indexing? It’s zero.”


Blueberries

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https://www.marketwatch.com/story/john-bogle-has-a-warning-for-index-fund-investors-2017-06-01

Ha. That article left off the most important part of what Bogle said that day.

“Now, what are the chances of everybody indexing? It’s zero.”

Taken from the article, "The market is not entirely owned by indexers, of course, and it never will be, and Bogle pointed out that as indexing increases to a certain point, it opens opportunities for active investors to exploit inefficiencies in the pricing of some stocks. But past that point, wherever it might be — somewhere beyond 75%, in his view — the market could become a dangerous place." 

Again, not something to change your strategy over, but I would not tell myself it couldn't happen.  Anything can happen in the stock market.