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I have a thought...it borderlines on conspiracy theory, so I don't take it too seriously...but I think index funds are actually damaging to the economy. It all

I have a thought...it borderlines on conspiracy theory, so I don't take it too seriously...but I think index funds are actually damaging to the economy. It all starts from the premise that if it's too good to be true, it probably is. Think about a truly reductionist outlook on the product of index funds: put money into this thing, with very little effort on your part, and you'll make enough money to retire on! Sounds way too good to be true, to just throw money at something and it makes you money. One argument is that well, you're investing in the US economy (or the global economy, depending on your index fund). You're putting faith into the economy as a whole...but that means you're also blindly investing into businesses that may not (and should not) be performing well. Companies that may be lagging behind will be artificially inflated in a groupthink (or I guess groupinvest) mentality. At a smaller level, this becomes a problem when those funds differentiate on things like market cap. If a company has a bad year and drops market cap from $2.5B to $1.8B, that means the company went from being a large cap to a mid cap company in the eyes of institutional investors. So based solely on market cap (and not fundamentals of the business), Vanguard will dump it from it's large cap funds and buy it up on it's mid cap funds. And if most people are only investing in the S&P 500 or Large Blend funds, then you're seeing a massive shift in ownership in companies solely based on one metric. How can this be sustainable for the overall economy? Warren Buffett and many successful investors have told people that you should treat a stock as owning a portion of a business. We've completely separated ourselves from that ownership (and responsibility) when we entrust our money in index funds. And when some of the largest companies are owned by some of the largest financial institutions, it seems like the companies are getting in bed with the same architects of our recent financial meltdowns. In conclusion, something just seems off about throwing money at a fund that makes somewhat arbitrary decisions for how it owns businesses, and supports the bigger businesses while penalizing the smaller ones (via groupthink and ownership).

galdosdi 10y ago
I don't think your idea is nuts at all. I see the TLDR of this article as (quoted from the article) "...active management has positive externalities, and if no one will pay for it, those benefits will disappear." It probably contributes to poor corporate governance. The more your shareholders don't even bother to vote their proxies or even think or read about them, the easier it is for management to gradually evolve into caring more about padding their position and making short term results look good than catering to long term shareholders It's a bit of a free-rider problem -- as long as there's enough active shareholders, passive shareholders can get a free ride and profit from the (averaged) wisdom of the active ones without paying for it in time/effort. But if that keeps growing, eventually the active shareholders who care are a minority in the company, and at that point management is incentivized to ignore the minority that cares and just "appease Wall Street", ie do whatever gives short term stock boosts. > And if most people are only investing in the S&P 500 or Large Blend funds BTW, IIRC, the largest firms are so large that most of the market by market cap consists of the largest few, so investing in just large cap vs investing in the total market is close to the same -- you have to manually skew towards medium and small if you don't want them to be negligible in your portfolio.

galdosdi 10y ago

I don't think your idea is nuts at all. I see the TLDR of this article as (quoted from the article) "...active management has positive externalities, and if no one will pay for it, those benefits will disappear." It probably contributes to poor corporate governance. The more your shareholders don't even bother to vote their proxies or even think or read about them, the easier it is for management to gradually evolve into caring more about padding their position and making short term results look good than catering to long term shareholders It's a bit of a free-rider problem -- as long as there's enough active shareholders, passive shareholders can get a free ride and profit from the (averaged) wisdom of the active ones without paying for it in time/effort. But if that keeps growing, eventually the active shareholders who care are a minority in the company, and at that point management is incentivized to ignore the minority that cares and just "appease Wall Street", ie do whatever gives short term stock boosts. > And if most people are only investing in the S&P 500 or Large Blend funds BTW, IIRC, the largest firms are so large that most of the market by market cap consists of the largest few, so investing in just large cap vs investing in the total market is close to the same -- you have to manually skew towards medium and small if you don't want them to be negligible in your portfolio.