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If you're a Vanguard customer (buying the flagship fund classes, I presume), you're expressing faith in CAPM[0] and EMH[1] on a significant level. Some active i

If you're a Vanguard customer (buying the flagship fund classes, I presume), you're expressing faith in CAPM[0] and EMH[1] on a significant level. Some active investors will probably in the long term scoop up some extra gains, but the question still remains: which of them, over what time horizon, and is that a risk you want to take? Vanguard gives you lots of no-commission funds with 1 day liquidity even in the mutual funds - plenty of room for you to try and time the market if you think you can have a go at active trading around some predictable flows if too many people are passively investing. Nothing stops you. [0]http://www.investopedia.com/terms/c/capm.asp http://www.investopedia.com/terms/c/capm.asp [1]http://www.investopedia.com/terms/e/efficientmarkethypothesis.asp http://www.investopedia.com/terms/e/efficientmarkethypothesi...

dsacco 10y ago
I think the parent commenter is more concerned about the economy's overall stability, and believes passive investors could be exploited due to mis-pricing index fund underlyings. I didn't interpret it as a worry about missing out on active investment, but I could be wrong.
- headmelted 10y ago
  ^^ Effectively this. My concern is that if everyone is in the passive investing boat then we're no longer following the market, we're making the market, and it's a big departure from the philosophical under-pinnings behind the idea of passive investing. (We started out letting active players make the market by placing good/bad bets and winning/losing. We got a market that was at least trying to find the right price and we did well due to the low expense ratios. Now that we're in the majority, I'm concerned that no-one is trying to find the right price anymore.) tldr; I have mixed feelings about passive investing over the long term if we're no longer small fish in a big ocean.
  - pitt1980 10y ago
    what's a good hedge against this?
  - lr4444lr 10y ago
    I don't understand the fear. If index funds dominate the market to the point of a near risk-free rate because that's what everyone's doing, you've effectively democratized the capital system to the benefit of the regular joe: companies still turn profits, and those become dividends. Dividends are why we buy stocks. That's what drives the whole system - not a zero-sum bilking of active investors. Yes, major growth spurts will probably be concentrated into a fewer select group of niche sectors and active traders, but that'll be their voluntary risk profile. EDIT - I highly recommend watching some of Robert Schiller's Financial Markets lectures on Yale Coursera about general investment theory. Bogle is saying good things, but he simplifies it in a way that I can see might sound disconcertingly incomplete. You're not wrong to ask these questions if you're conscientious and smart enough to want more in-depth answers.
    - alex8022 10y ago
      But then, say you come a long with a new company going public... you're not large enough to be in the S&P 500, so if everyone only invests in S&P 500 index funds, no one will buy your stock. Similarly, if you're Apple (the largest company), and you have a really bad quarter, say you lose $100B, no one would sell your shares, because they're passive investors. Obviously, these are edge cases (we'll never be 100% passive), but there is some concern that there will be a lock-in effect for companies currently in the S&P... It will be harder to grow if you're not in it, and it'll be harder to fail if you are.
      - lr4444lr 10y ago
        It's a perfectly valid question. In my very cautious humble opinion, I think what it means is that the style/size matrix[0] will get squeezed more into a single spectrum: large companies will be pressured into stabilizing and delivering dividends and small ones will compete to grow large enough to get a piece of the passive investment gravy train. Apple can have a bad quarter, but it's just one company. It can't keep having a bad quarter. And if they start to and have to downsize to stay alive, they would by doing that hasten themselves out of a market cap that would qualify them for the index. There's also no reason why passive indices have to reflect the total market weighted for market cap. [0]https://corporate.morningstar.com/US/documents/MethodologyDocuments/FactSheets/MorningstarStyleBox_FactSheet_.pdf https://corporate.morningstar.com/US/documents/MethodologyDo...
  - rsync 10y ago
    "My concern is that if everyone is in the passive investing boat then we're no longer following the market, we're making the market, and it's a big departure from the philosophical under-pinnings behind the idea of passive investing." I'm intrigued by your suspicion ... but I can't put my finger on the exact manner that this might play out ... it's really hazy. It seems to me that the effect of everyones money going into index funds would be that firms large enough to be in the index would have less and less pressure to issue dividends ... if there is a ready market of buyers of your stock based solely on your size then why bother ? If money flows, by autopilot, into an asset class wouldn't we expect that asset class to return less and less as time goes on ?
    - icebraining 10y ago
      Size-based index funds are just one type, there are others, including ones that track stock of high dividend yielding companies. Just because passive investors aren't trading daily doesn't mean they won't adjust to better funds, forcing companies to pay out.
  - dv_dt 10y ago
    I think the long long term problem is that the stock market has an increasing disconnect between investment in new businesses doing anything well new, and to an increasing degree novel business practices in existing businesses. Yes, there are some IPOs, but overall new business starts are still in decline, and large portions of financial markets seem both too systematically risk averse, and yet willing to follow other risks blindly.
malchow 10y ago
Say more. Why do I believe in the Capital Asset Pricing Model and Efficient Markets (both proven wrong) if I invest in Vanguard's cheap S&P 500 ETF? I invest in their S&P 500 ETF because it's the cheapest way to get diversified exposure to the 500 largest American companies, and I believe that the 500 largest American companies will be more valuable in the future as a combination of valuation, scale, and cash flows to owners, than they are right now.
- AnimalMuppet 10y ago
  The S&P 500 is a reasonable, good investment. I think Efficient Markets is saying "you can't do better". That claim may be false. And yet, it may be close enough to true, especially for a small investor, that Vanguard's ETF is good enough (that is, it's not worth the time and effort to try to find something better).
- jackcosgrove 10y ago
  While you may not believe in CAPM and EMH and still invest in Vanguard funds, many do both. I used to participate in the Bogleheads forum and encountered many doctrinaire EMH proponents there. It's not an unreasonable inference to connect the two.
- ctkrohn 10y ago
  If the Efficient Markets Hypothesis (in its stronger forms) is false, there should be managers who are able to identify the cheapest stocks within the S&P 500 and thereby outperform the index. A disbeliever in EMH should look to identify these managers and pay them some fee, rather than simply investing in the index and trying to minimize fees. I think it's plausible that these managers exist, but they're impossible to identify ex ante. Furthermore, a smart manager will charge fees that are equal to the alpha they generate. So even if the EMH is false in some broad sense, individual investors should act as if it were true and simply invest in low-cost diversified funds.
  - hsitz 10y ago
    You say "A disbeliever in EMH should look to identify these managers and pay them some fee". In the next breath you say that even if the EMH is false "individuals investors should act as if it were true". This makes your post somewhat ambiguous; not so clear about which position you're advocating. How "plausible" is it that these managers are "impossible to identify ex ante."? Why is it plausible? "Impossible" seems like a pretty strict standard (akin to strong EMH), why not just say instead that identifying such managers before they outperform is "practically impossible" or just "really, really, damn hard and something that you're deluding yourself about if you think you can do it." Also (assuming it is your position), it's important to clarify that you don't disagree with the assertion that many people do identify market-beating managers before they outperform. Probably millions of people have done it; it happens every day. What they don't do (in my opinion) is use skill or knowledge to identify the outperforming managers. If they do identify an outperforming manager (of which there are always many) it happens because of chance or luck. (Just as, IMO, the outperformance itself of almost all outperforming managers is due to luck or chance, not skill.)
random_comment 10y ago
faith in EMH[1]: This is only true if you make a single lump sum investment into Vanguard without looking at the price.

dsacco 10y ago

I think the parent commenter is more concerned about the economy's overall stability, and believes passive investors could be exploited due to mis-pricing index fund underlyings. I didn't interpret it as a worry about missing out on active investment, but I could be wrong.

headmelted 10y ago
^^ Effectively this. My concern is that if everyone is in the passive investing boat then we're no longer following the market, we're making the market, and it's a big departure from the philosophical under-pinnings behind the idea of passive investing. (We started out letting active players make the market by placing good/bad bets and winning/losing. We got a market that was at least trying to find the right price and we did well due to the low expense ratios. Now that we're in the majority, I'm concerned that no-one is trying to find the right price anymore.) tldr; I have mixed feelings about passive investing over the long term if we're no longer small fish in a big ocean.
- pitt1980 10y ago
  what's a good hedge against this?
- lr4444lr 10y ago
  I don't understand the fear. If index funds dominate the market to the point of a near risk-free rate because that's what everyone's doing, you've effectively democratized the capital system to the benefit of the regular joe: companies still turn profits, and those become dividends. Dividends are why we buy stocks. That's what drives the whole system - not a zero-sum bilking of active investors. Yes, major growth spurts will probably be concentrated into a fewer select group of niche sectors and active traders, but that'll be their voluntary risk profile. EDIT - I highly recommend watching some of Robert Schiller's Financial Markets lectures on Yale Coursera about general investment theory. Bogle is saying good things, but he simplifies it in a way that I can see might sound disconcertingly incomplete. You're not wrong to ask these questions if you're conscientious and smart enough to want more in-depth answers.
  - alex8022 10y ago
    But then, say you come a long with a new company going public... you're not large enough to be in the S&P 500, so if everyone only invests in S&P 500 index funds, no one will buy your stock. Similarly, if you're Apple (the largest company), and you have a really bad quarter, say you lose $100B, no one would sell your shares, because they're passive investors. Obviously, these are edge cases (we'll never be 100% passive), but there is some concern that there will be a lock-in effect for companies currently in the S&P... It will be harder to grow if you're not in it, and it'll be harder to fail if you are.
    - lr4444lr 10y ago
      It's a perfectly valid question. In my very cautious humble opinion, I think what it means is that the style/size matrix[0] will get squeezed more into a single spectrum: large companies will be pressured into stabilizing and delivering dividends and small ones will compete to grow large enough to get a piece of the passive investment gravy train. Apple can have a bad quarter, but it's just one company. It can't keep having a bad quarter. And if they start to and have to downsize to stay alive, they would by doing that hasten themselves out of a market cap that would qualify them for the index. There's also no reason why passive indices have to reflect the total market weighted for market cap. [0]https://corporate.morningstar.com/US/documents/MethodologyDocuments/FactSheets/MorningstarStyleBox_FactSheet_.pdf https://corporate.morningstar.com/US/documents/MethodologyDo...
- rsync 10y ago
  "My concern is that if everyone is in the passive investing boat then we're no longer following the market, we're making the market, and it's a big departure from the philosophical under-pinnings behind the idea of passive investing." I'm intrigued by your suspicion ... but I can't put my finger on the exact manner that this might play out ... it's really hazy. It seems to me that the effect of everyones money going into index funds would be that firms large enough to be in the index would have less and less pressure to issue dividends ... if there is a ready market of buyers of your stock based solely on your size then why bother ? If money flows, by autopilot, into an asset class wouldn't we expect that asset class to return less and less as time goes on ?
  - icebraining 10y ago
    Size-based index funds are just one type, there are others, including ones that track stock of high dividend yielding companies. Just because passive investors aren't trading daily doesn't mean they won't adjust to better funds, forcing companies to pay out.
- dv_dt 10y ago
  I think the long long term problem is that the stock market has an increasing disconnect between investment in new businesses doing anything well new, and to an increasing degree novel business practices in existing businesses. Yes, there are some IPOs, but overall new business starts are still in decline, and large portions of financial markets seem both too systematically risk averse, and yet willing to follow other risks blindly.

malchow 10y ago

Say more. Why do I believe in the Capital Asset Pricing Model and Efficient Markets (both proven wrong) if I invest in Vanguard's cheap S&P 500 ETF? I invest in their S&P 500 ETF because it's the cheapest way to get diversified exposure to the 500 largest American companies, and I believe that the 500 largest American companies will be more valuable in the future as a combination of valuation, scale, and cash flows to owners, than they are right now.

AnimalMuppet 10y ago
The S&P 500 is a reasonable, good investment. I think Efficient Markets is saying "you can't do better". That claim may be false. And yet, it may be close enough to true, especially for a small investor, that Vanguard's ETF is good enough (that is, it's not worth the time and effort to try to find something better).
jackcosgrove 10y ago
While you may not believe in CAPM and EMH and still invest in Vanguard funds, many do both. I used to participate in the Bogleheads forum and encountered many doctrinaire EMH proponents there. It's not an unreasonable inference to connect the two.
ctkrohn 10y ago
If the Efficient Markets Hypothesis (in its stronger forms) is false, there should be managers who are able to identify the cheapest stocks within the S&P 500 and thereby outperform the index. A disbeliever in EMH should look to identify these managers and pay them some fee, rather than simply investing in the index and trying to minimize fees. I think it's plausible that these managers exist, but they're impossible to identify ex ante. Furthermore, a smart manager will charge fees that are equal to the alpha they generate. So even if the EMH is false in some broad sense, individual investors should act as if it were true and simply invest in low-cost diversified funds.
- hsitz 10y ago
  You say "A disbeliever in EMH should look to identify these managers and pay them some fee". In the next breath you say that even if the EMH is false "individuals investors should act as if it were true". This makes your post somewhat ambiguous; not so clear about which position you're advocating. How "plausible" is it that these managers are "impossible to identify ex ante."? Why is it plausible? "Impossible" seems like a pretty strict standard (akin to strong EMH), why not just say instead that identifying such managers before they outperform is "practically impossible" or just "really, really, damn hard and something that you're deluding yourself about if you think you can do it." Also (assuming it is your position), it's important to clarify that you don't disagree with the assertion that many people do identify market-beating managers before they outperform. Probably millions of people have done it; it happens every day. What they don't do (in my opinion) is use skill or knowledge to identify the outperforming managers. If they do identify an outperforming manager (of which there are always many) it happens because of chance or luck. (Just as, IMO, the outperformance itself of almost all outperforming managers is due to luck or chance, not skill.)

random_comment 10y ago

faith in EMH[1]: This is only true if you make a single lump sum investment into Vanguard without looking at the price.