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I'm a big believer in index funds and have been putting my money into them for a long time. But... you have to wonder where this is all ending up as more and mo

• aantix 10y ago
  I think you're correct on your last statement; anytime there's predictability introduced into a system, there's going to be a counter-action you can perform to exploit those tendencies.
• n72 10y ago
  There are companies which will fairly obviously perform well in the future. However, because of active investing, this projected performance gets priced in, so they aren't a bargain. If the whole world except one active investor invested in indexes, then the active investor would have a very easy time, since that projected performance wouldn't be priced in and the stock would be a bargain.
  • OscarCunningham 10y ago
    Who would that investor trade with?
    • icebraining 10y ago
      I'm not an expert, but index funds still purchase the stocks, so when the active investor bought a stock at an increased price, it would increase the market cap and so the index fund would buy some more of it from them.
      • OscarCunningham 10y ago
        Nah, because the value of the stock that the index fund already owned would also increase in the same proportion.
        • icebraining 10y ago
          Fair enough, for stocks the index already owned, but what about for the others? If the investor took a stock that wasn't in the top 500 and inflated its value above the 500th stock, wouldn't an S&P 500 index fund then buy it?
    • n72 10y ago
      It's a thought experiment.
• Ericson2314 10y ago
  I think the more worrisome problem is a lack of shareholder input in corporate decision-making.
  • icebraining 10y ago
    Index funds still have an input on the corporations. https://about.vanguard.com/vanguard-proxy-voting/update-on-voting/ https://about.vanguard.com/vanguard-proxy-voting/update-on-v...
    • Ericson2314 10y ago
      Ok the proxy vote is good—I guess the real problem when everyone's investments are so diverse, it's impossible to be an educated voter in all cases.
      • countingteeth 10y ago
        No. Fund shareholders do not get a proxy vote in the underlying stocks. Not with Vanguard or most large funds anyway. The fund votes. And the fund managers and analysts will have a lot more resources and information on their holdings than fund shareholders. That being said, there are all sorts of problems with the incentives here.
        • Ericson2314 10y ago
          Oh the link above mentioned proxy votes, but to be honest I only skimmed it. Yes what you say does sound worrisome.
• 11thEarlOfMar 10y ago
  In any auction, there has to be the first person declaring what the item is worth. If 100% of the investing is passive, there is no first bidder, so how is a stock's value determined? In the current situation, 34% of the money passively follows the active investors. That gives the active investors a 34% amplifier in their action. I'd say the possible bad news is that the larger the passive pool, the less capital it takes to manipulate a stock price.
  • qaq 10y ago
    This is exactly how it will balance out. If this passes a threshold such that funds that take advantage of the phenomena will produce a meaningfully higher return than index funds then money will start flowing into such funds balancing out the effect.
    • nradov 10y ago
      Not just actively managed funds. There will always be proprietary traders speculating with their own or their employer's capital. As long as some kind of active investors make up ~10% of the market that will be sufficient for price discovery.
      • 11thEarlOfMar 10y ago
        That 10% will be insiders.
        • sokoloff 10y ago
          Who better to know the prospects of a company?
    • OscarCunningham 10y ago
      I don't understand how this is supposed to work. Won't active investing still be a zero-sum game? So on average won't they still be making the same as indexers?
• internaut 10y ago
  > self-correcting as sophisticated investors would notice the pricing errors What was it Keynes said about rationality and being solvent?
  • icebraining 10y ago
    Probably nothing: http://quoteinvestigator.com/2011/08/09/remain-solvent/ http://quoteinvestigator.com/2011/08/09/remain-solvent/
    • crdoconnor 10y ago
      "There is nothing so disastrous as a rational investment policy in an irrational world." ^^ He said that though.
• gregpilling 10y ago
  Your last sentence is correct. See the "Nifty 50" https://en.wikipedia.org/wiki/Nifty_Fifty https://en.wikipedia.org/wiki/Nifty_Fifty "The stocks were often described as "one-decision", as they were viewed as extremely stable, even over long periods of time. The most common characteristic by the constituents were solid earnings growth for which these stocks were assigned extraordinary high price-earnings ratios. Fifty times earnings was not uncommon."
• keltex 10y ago
  The other thing to keep in mind that index funds slice and dice the market in many different ways. The classic "Index 500" fund is a market-cap weighted fund. But there are many other types of funds. For example, Vanguard has 62 different index funds. And there are fundamental weighted index funds which, "...may be based on fundamental metrics such as revenue, dividend rates, earnings or book value". (http://www.investopedia.com/terms/f/fundamentally_weighted_index.asp http://www.investopedia.com/terms/f/fundamentally_weighted_i...) There are funds which take different selections of the market (top 1000 stocks or top 100 stocks, etc). So somebody might purchase an index fund and think they are investing passively, they are really actively choosing a passive strategy.
• Symmetry 10y ago
  It gets easier and easier to beat the market (due to less people trying) until eventually investors can make enough money doing that to earn the fees they charge for trying. There's an equilibrium when that happens. EDIT: Or, to put it in EHM analogy terms, the number of people looking for loose change on the sidewalk will go down until there are few enough to support themselves from the money people actually drop.
• paulpauper 10y ago
  but that won't happen because companies will still have to disclose financials, and companies with poor fundamentals will be shorted by arbitragers. The pricing mechanism can never go away completely
  • hilop 10y ago
    Sure for companies that are headed to bankruptcy. But what about companies that are overpriced and cover expenses but never pay a dividend?
    • Godel_unicode 10y ago
      There are indexes of dividend-paying stocks. If the market decides dividends are important, companies which pay them will do better.
• Taek 10y ago
  Well, you've always got insiders in the sense that most people know their own industry better than they know other industries. Passive funds are great when you want to diversify or lack knowledge. But for example I've got a ton of money in cryptocurrency right now, it's my field and I've got way better-than-average knowledge about some of the coins. This helps me make informed investments, and I've been able to beat the passive rate by doing high risk investing into assets that were obviously priced incorrectly. I'm not a day trader. I'm like the guy who goes about his way normally, but isn't afraid to pick up $20 off the ground when I see it. I spend some time looking for it, but it's not where I put most of my energy.
  • devilsavocado 10y ago
    Can you expand on how having better-than-average knowledge about some crypto currencies allows you to make money investing in them? I doubt you mean that you actually have knowledge of when and how the price is going to change. Are you just betting on a general increase in value, or doing some form of pairs trading or arbitrage? How comfortable are you with rapid 30% price swings?
    • Taek 10y ago
      I'm very comfortable with rapid price swings. My strategy is to buy when they are silly underpriced and wait. They may drop further but almost always if there's a good dev team it'll jump when they have big enough news. So you just wait. I've yet to be bold enough to short something overpriced but there are plenty of cases where something has struck me as obviously overpriced and within a year the price has corrected. Game plan definitely involves waiting months at a time.
• SomeStupidPoint 10y ago
  > Individual stock prices would not reflect the true value of a company. I would argue that this is already the case. I invest solely in market-wide or top-75%-of-market-caps strategies (in stocks), because they're the only strategies that seem to accurately reflect my opinion of the markets: 1. The game is rigged. 2. People are dumb. (Especially me.) Analysis of those strategies seems to indicate that they outperform even (traditional) index funds over long periods (likely because they're quicker to respond to risk/opportunity during transitional periods, eg, a new technology coming out). I like to think it's because my premises are true, but there's lots of other premises that lead to the same model of investing, so it's hard to say. (I think of them as a really diverse index fund, so at some level, it's really just the advice that Warren Buffet gave about long term investing.) If everyone used this strategy the market would... basically do nothing once a company IPO'd, because everyone would hold a portion of every company forever (creating no selling once the initial bidding on IPO was over). That's not necessarily such a bad thing, because it would remove a lot of the noise that boards respond to while still incentivizing (healthy) long-term growth (because the only way the stock increases in value without trading and the current market gambling is from the underlying asset -- the corporation -- increasing in value, and distributing that as payouts or buybacks). There still is a valuation mechanism, however, because the passive funds do need to buy and sell when new stocks appear or someone is looking to change a position (which, is every IPO plus whatever is needed to generate cashflow from the portfolio), and how they negotiate that provides a value on the stock, even if they're just rolling shares they control between pools and clients of their own. However, we'd still have the whole pipeline of pre-IPO private ownership, which definitely wouldn't settle in to the same kind of lock-in, but already uses the same kind of invest-across-the-board strategies. So in short, I'm actually very unworried about the effects of main Wall St stock markets settling down due to most money being passively invested in long-term growth strategies, because it actually deincentivizes a lot of bad behavior on the part of trading firms. Much harder to execute your fraud if most people aren't going to react to it in any capacity, and won't be closing out their positions for 20-40 years, if ever. It's also perhaps easier to get a case to stick if you have basically every investor to choose a client from, because they'd all be impacted by those actions.
• walshemj 10y ago
  I suspect that if there is a big bond crash which is likely to happen a lot of those invested in index funds that robotically invested in bonds will be taking some big losses.
  • saryant 10y ago
    Yeah, that's the point. You rise with the market, you fall with the market.
    • walshemj 10y ago
      and if you pension fund is 50/50 and theirs a bond crash shortly before you retire?
      • saryant 10y ago
        You're arguing against a strawman. Index funds do not protect you from market crashes, that's not the point and never was. Index funds save you from forking over tens or hundreds of thousands of dollars in fees to active managers who may or may not outperform the market as a whole.
• OliverJones 10y ago
  Ned Johnson had it right way back when. Why would anybody want average returns when they could pay him big money for below-average returns and the occasional black-monday disaster? Seriously, index fund investing assumes an optimistic outlook. It assumes the managers of companies will do an OK job in the long term and the companies will grow. Index funds allow investors to participate in that growth without having a big chunk of it going into Mr. Johnson's pocket. A low fee burden turns OK company performance into acceptable retirement savings growth. It's not a zero sum game. It's a slightly-positive-sum game. That means a lot of people can play and slightly win. As for pricing the equities, the fundamental qualities of the businesses behind them are, even in the stock market casino of the 21st century, still important. Warren Buffet understands fundamentals. There's no reason a market dominated by index funds must ignore them. There are two other aspects of successful index investing. 1. Diversification. Don't put all your money in one index. What if you have all your money in the NASDAQ index when the cultural narrowmindedness of Silicon Valley (the rule of young white brogrammers) catches up with them? 2. Disciplined rebalancing. Set a goal for diversification percentages: 60% growth equities, 20% growth-and-income, 10% nonUSA, 10% bonds for example. When your investment values move away from those percentages, sell the excess in one category and reinvest it in the other categories. This amounts to buy-low sell-high. It will serve as a ratchet to capture the upside and limit the downside. Panic buying and selling is for the other guy. I'm grateful to that other guy; he's helped me set up a nice 401k balance.
  • shostack 10y ago
    Any good reading on how to determine your allocation strategy? I read up on Bogleheads but there isn't always much on the "why" that is backed by data.
    • beart 10y ago
      I found this link useful when deciding how to invest my 401k https://www.reddit.com/r/personalfinance/wiki/401k_funds https://www.reddit.com/r/personalfinance/wiki/401k_funds
    • OliverJones 10y ago
• hilop 10y ago
  Alliances Bernstein wrote a Paper arguing that index fund investing is essentially communism -- letting some arbitrary authority control the economy.
  • CyberDildonics 10y ago
    Philosophy doesn't have much place when it comes to individual incentives.
• jganetsk 10y ago
  Warren Buffett says it's OK, and has an excellent explanation for this. If I recall correctly: imagine you take all the investors in the US economy and put them in a room. Divide the room in halves. One side contains all the active investors, the other side contains all the passive investors. If each side owns roughly half of the economy, their returns will be equal. In that case, it's better to sit on the side with the lower fees... so one should naturally sit on the passive side. Setting Warren Buffett aside, what you neglect to mention is that the stock market is both a primary and secondary capital market. We can speculate about how to speculate... whether to be passive or active... but this concerns only the functionality of the secondary market. There's still primary market functionality: companies issue stock to raise capital, buyback stock, and issue dividends. Thus, even if all the investors are passive, there's still always one active agent in the game: the company itself. And a capitalization-weighted index is ideally suited for this activity: it automatically shifts capital away from companies buying back stock (essentially, companies returning money to investors) to those issuing new stock (essentially, companies seeking to raise capital).
  • joezydeco 10y ago
    Buffett is close to winning a $1 million, 10-year bet he made with the head of the hedge fund Protege Partners. The bet was simple. Buffett would invest in a Vanguard S&P 500 index fund, and the hedge fund could do anything they wanted. http://fortune.com/2016/05/11/warren-buffett-hedge-fund-bet/ http://fortune.com/2016/05/11/warren-buffett-hedge-fund-bet/ http://www.npr.org/2016/03/10/469897691/armed-with-an-index-fund-warren-buffett-is-on-track-to-win-hedge-fund-bet http://www.npr.org/2016/03/10/469897691/armed-with-an-index-...
    • nostromo 10y ago
      The irony of course is that Buffett became one of the world's richest people by being an active investor.
      • jacques_chester 10y ago
        True, but he (and Munger) generally invest quite conservatively. He doesn't buy for capital gain, but to hold indefinitely. He buys businesses he understands, with financials he understands, for prices he figures reflect a fair discount on the economic value, plus a generous margin of error. When full ownership is taken (his preferred option), the original management is almost always left in place. No rules or guidance are given. The subsidiaries work however they worked before acquisition. That said, after reading through his 50 Berkshire Hathaway letters, the main lesson I drew was: own insurance companies which underwrite for profit under all economic conditions.
• deleted 10y ago
  [deleted]
• Spooky23 10y ago
  They are creating managed funds that make money, you can't access them. The problem with index funds is that a lot of the active capital is moving to closed markets. So when the bogleheads endlessly debate the perfect portfolio mix, they miss the point that they have zero exposure to private equity and other markets. Index funds are better than managed funds, and are mostly better than individual equities. That doesn't mean that 100% of your money should be in them.
• csomar 10y ago
  isn't that already happening?
• Applejinx 10y ago
  Simple. When everybody is in an index fund composed of the whole market, then everybody agrees their money ought to become more valuable and poof, so it is. What could possibly go wrong?
• Terr_ 10y ago
  > But say in the extreme case, it got to the point where all funds were invested passively This came up a couple months ago on HN [0], and to that scenario I say: > Yeah, it's a bit like saying: "But what if all the animals in the ecosystem became helpless herbivores?" [0] https://news.ycombinator.com/item?id=12368136 https://news.ycombinator.com/item?id=12368136
• tommynicholas 10y ago
  Agreed - it's what the average investor should do. Even if it's really hard to beat Index Funds consistently, there are two factors that will make active trading always important: 1. Some people will beat the market, and regardless, someone has to try or there's a massive opportunity left on the table. 2. Indexing actually has more of a certain type of risk than passive investing, because if you take a huge loss for some period of time, you can't hedge it and cut the short term loss. You have to just hold. Active investing can be really valuable for folks as they enter phases of their life where big losses are unacceptable and they're willing to forgo some of the upside.
  • saryant 10y ago
    Your second point has nothing to do with indexing and everything to do with asset allocation. If you're nearing retirement, you shouldn't be holding risky assets like equities.
    • adwn 10y ago
      > If you're nearing retirement, you shouldn't be holding risky assets like equities. That is not quite right. When entering retirement, most people can expect to live for at least 20 more years, which means they should hold a non-insignificant fraction of their wealth in stocks.
      • sokoloff 10y ago
        Exactly. Further, those who find themselves in the fortunate situation of being overwhelmingly likely to leave a significant estate to their children should consider investing their funds according to the life expectancy of the children, not their own.
• spectrum1234 10y ago
  Obviously day traders and fundamental investors still are doing their job to price each individual stock accurately. This doesn't mean PASSIVE investors can't all do the same thing. In fact because risk over time is the fundamental reason passive investors make money, they can do exactly this. This isn't some loophole in the system. They are taking risk!!! It's amazing how many people don't understand this. (edited)
• JulianRaphael 10y ago
  Even if you would only have passively invested funds, you'd still have the pricing mechanism. Each index fund has an individual portfolio distribution and different rules of how to adjust it to market changes. Passive investing doesn't mean that there is no "active" part to it. Furthermore, a great number of stocks won't be part of any index fund, hence you'd still have active investors (humans and/or machines).
• wutbrodo 10y ago
  There are _always_ investors trying to beat the market on fundamentals, even if many of them are just overconfident. We'll never got to the point where the entire market is index funds because, as more people invest in index funds, the possibility (and pay-off) of actual alpha by picking stocks rises. This isn't sustainable because people will notice the sustained performance difference between stock-picking and index funds (the same way we do now) and the opposite tendency will push things back towards an equilibrium