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The problem is that Wall Street fund managers who beat the market almost never do so consistently, i.e. there is insufficient evidence to reject the null hypoth

The problem is that Wall Street fund managers who beat the market almost never do so consistently, i.e. there is insufficient evidence to reject the null hypothesis "all actively managed funds have a roughly equal (low) chance of beating the market" in favor of "this fund knows how to beat the market consistently and will probably do so next year." So a rational personal investor, who does not have insider information, is best off not trying to beat the market. Even though the market as a whole may be best off with everyone trying to beat it.

nostrademons 11y ago
Yeah, I know the rationale behind why index funds exist. The majority of my wealth is in them, after all. The parent poster, however, is asking "What's the catch? Where's the trade-off to investing in index funds, and what sort of new systemic risks does widespread adoption of them bring to the financial system?" He's right to ask that: there is always a catch, because the financial system is about distributing & incentivizing the wealth of society and doesn't directly produce any wealth itself. I'm saying that the catch is in diminishing returns from the index itself. A well-subscribed index fund, by definition, will always give you the median return of the market it tracks. I'm saying that the effect of large amounts of capital pouring into index funds is that the mean and median returns will diverge. Market inefficiencies become more prevalent as fewer eyes are on each business; as a result, people who successfully exploit them become richer than they would otherwise. Wealth becomes increasingly more concentrated in the few people that actively invest (usually with insider information) and do so successfully. Passive investors continue to make the median return, but the median return falls further behind the mean return. We're seeing exactly this phenomena right now. I haven't seen anyone else who has explicitly linked it to the rise of index funds & passive investing, but I wouldn't be surprised if it's related.

nostrademons 11y ago

Yeah, I know the rationale behind why index funds exist. The majority of my wealth is in them, after all. The parent poster, however, is asking "What's the catch? Where's the trade-off to investing in index funds, and what sort of new systemic risks does widespread adoption of them bring to the financial system?" He's right to ask that: there is always a catch, because the financial system is about distributing & incentivizing the wealth of society and doesn't directly produce any wealth itself. I'm saying that the catch is in diminishing returns from the index itself. A well-subscribed index fund, by definition, will always give you the median return of the market it tracks. I'm saying that the effect of large amounts of capital pouring into index funds is that the mean and median returns will diverge. Market inefficiencies become more prevalent as fewer eyes are on each business; as a result, people who successfully exploit them become richer than they would otherwise. Wealth becomes increasingly more concentrated in the few people that actively invest (usually with insider information) and do so successfully. Passive investors continue to make the median return, but the median return falls further behind the mean return. We're seeing exactly this phenomena right now. I haven't seen anyone else who has explicitly linked it to the rise of index funds & passive investing, but I wouldn't be surprised if it's related.