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Here's what bothers me. Ten years ago I was still in school and came across Malkiel's 'A Random Walk' book. Then I started reading Graham's 'Intelligent Investo

• uiri 9y ago
  Conventionally, when bond yields go down, stocks go up. Interest rates (and, consequently, bond yields) have been very low for a number of years now. This has led to a lot of capital being deployed in the stock market instead. So that explains why there is a lot of money which wants to be invested in the stock market right now. This may or may not be tempered by a near-future hike in interest rates. Vanguard started out in 1975 but it only had one fund - a mutual fund tracking the S&P 500 - for the first decade of its existence. It has added new funds since the crash of 1987. If you look at the market since that time, the dot-com bubble was for tech stocks specifically and the housing bubble didn't have much to do with stocks at all (until after it burst, anyways). There hasn't been demand for the entire stock market since Vanguard started to become popular and well-known. This is why demand for index funds is near an all-time high. Throwing everything into Vanguard isn't a bad idea. Buying AAPL, WFC, MMM and VBR (or similar) is not a bad idea. Dividend aristocrats isn't a bad idea. You can come close to replicating market performance with a small subsection of the market. If you have good returns from your rental real estate, keep it. Or rather, keep at least some of it for diversification. I too have a thing for contrarianism but I think that some stock strategy is worth pursuing. The people whose portfolios do best are those who forget about them[0] [0] http://www.businessinsider.com/forgetful-investors-performed-best-2014-9 http://www.businessinsider.com/forgetful-investors-performed...
• fennecfoxen 9y ago
  You shouldn't worry about ETFs and index funds being in a bubble per se. ETFs are structured out of holdings of other stocks. There are built-in mechanisms that keep their price in line with these other stocks: specifically, if the price diverges, it becomes profitable for the big traders and the like to buy other stocks and turn them into shares of the ETF, or vice versa. Provisions exist for doing this, so for a widely-traded ETF, the market will therefore be pretty efficient and the ETF itself will be priced fairly relative to its constituent stocks. (For a thinly traded no-name ETF, this may not be as true, however, and the prices may diverge - but we're still taking a few percent rather than, like, ten percent.) So worry about a bubble in the stocks the ETF holds, instead. Unlike ETF-to-stock drift, that isn't something that day traders can fix: only big-time active investors, hedge funds and the like with billions in assets and insane risk tolerance who are seeking market-beating returns, can actually trade enough volume to move the price on big stocks like that, and if big-time passive institutional investors (like masses of individuals armed with ETFs, or pension funds, who are not in it to beat the market) happen to be too irrationally exuberant about stocks, the hedge funds may find it too risky or not profitable enough to trade enough that it corrects the stock price back to what that price should be. But if you believe in a bubble in those stocks in general, you'll probably have to look beyond big names like AAPL and 3M that are already in your index fund, and you'll be back spending hours a day doing that beat-the-market research.
  • tlrobinson 9y ago
    I think the parent comment was suggesting stocks could be a in a bubble due to the popularity of ETFs/index funds.
    • pedrocr 9y ago
      That can only be the case if people are moving money from other assets into stocks because of index funds. Maybe that's happening (less CDs perhaps?) but the argument for indexing is much more "stop buying expensive managed stock funds and use much cheaper stock index funds". And that shouldn't create a bubble in stocks because there is no more capital invested in total.
    • 9y ago
• danielbarla 9y ago
  I don't think it's a "bubble" per se, since I believe the EFT approach is very sound. That said, there's an interesting relationship between ETFs and speculation; essentially, the ETF approach relies on the market being highly or somewhat efficient. In turn, the level to which the market is efficient is dependent on people doing their homework and placing informed bets on stocks. Essentially, doing their own evaluations of the "true value" of various stocks. If most investors move towards ETFs, the number of people performing these valuations / bets will decrease, lowering the quality of the valuations. As a result, the efficiency of the market will be lower, and ETFs will be less viable. Or, put another way, having a large part of the market blindly invested in ETFs opens gaps for speculation. The price of various stocks will be further away from their real value, allowing you to have a more reasonable shot at "beating the market" by guessing the real price better.
  • exelius 9y ago
    Retail investors are moving towards ETFs. Institutional investors can still make a little bit more money with active management. An extra 0.05% average return may not matter to a retail investor, but if you're managing a $35 billion fund, that's still an extra $1.75 million. I do expect the "alpha" gap between active management and passive index investing to close as robotrading becomes the norm. As alpha drops in a mass-robotrading scenario, trade volume tends to increase as more and different tactics are required to get the same returns. This arms race maintains market liquidity, while index funds provide a safe "baseline" for retail investors. It's really not a bad system.
• pedrocr 9y ago
  Index funds, by simple math, return exactly the average of the market with less fees, so they are strictly better than the average managed money which returns the same with more fees: https://web.stanford.edu/~wfsharpe/art/active/active.htm https://web.stanford.edu/~wfsharpe/art/active/active.htm And your ideas of picking 3 stocks + small cap is just that, an active bet that deviates from the market composition. Unless you've gone back on your conclusion that you're not Peter Lynch it's probably not much of a path. The only risk of rising index fund usage is that the market will cease being efficient. The way I see it is if that starts happening strongly (and it will take a lot more indexing than currently exists) first the market will become more volatile because price discovery will be worse with less people making bets. Then at some point if there are too few active investors indexing will become less viable because it will be easier for active investors to "steal" money from indexers by trading ahead of them and using other advantages over someone that's just buying and holding. This will make the index fund deviate from the index itself and it becomes unusable. I find these scenarios extremely unlikely because of the "Intelligent Investor" crowd you mention. There is indeed a premium paid to people that bring actual good information to the market. Buffett and others like him still make a lot of money, everyone else gets to ride along the efficient market they create. Buffett by the way recomends index funds. I'd love a reasonable contrarian view on this though. Most I've seen are just fund managers trying to justify their unjustifiable fees that create no value.
• exelius 9y ago
  My line of thought is this: inflation is ~3% a year (hasn't been that high in a while, but just wait), and market returns average 5% (aka beta) a year with some level of volatility. By definition, the alpha of an index fund is zero minus fees. I'm willing to trade a guaranteed-small negative alpha for the reduction in volatility in alpha that I would have across a portfolio across years. I've still got overall market volatility to contend with, but my time horizon is long so that gets pushed to the side. Index funds are a perfect choice for retail investors like yourself. But retail investors are a small percentage of the market; institutional investors make up the bulk of the transaction volume that provides liquidity for the rest of the market. Because they trade stocks millions of times a day, you're never going to beat them at the stock picking game. But their activity does push prices up across the board -- because the assets the institutional investors are trading are the basis of the index funds the retail investors are buying. So there's not really a bubble in an asset class if retail investors move to index funds, because the retail investor is buying a little bit of everything. If anything, there is a bubble on certain stocks that consumers are familiar with (i.e. AAPL, AMZN, GOOG, FB, etc.) But by buying the index, you're buying both the stocks that are overvalued and the ones that are undervalued. Now, certain index funds may eventually become out of whack with respect to overall market return: the S&P500 is generally considered to model the overall economy well, but that might not always be the case. That's fine, if you feel one index is becoming overvalued, weight your portfolio into another index. Or if you feel equity in general is overvalued, shift your portfolio into T-bills. And yeah, for me, the decrease in anxiety is totally worth it. The economy is either doing well, or it's not, but in either case my money is along for the ride.
  • iopq 9y ago
    Then you should just buy a long term bond fund along with an index. The longer term bond funds tend to have a positive alpha along with a negative beta. That means your returns will be lower than just having stocks, but your risk-adjusted returns with be better.
• PakG1 9y ago
  Heh. Talk about timing. Timely article. http://www.businessinsider.com/steven-bregman-etfs-passive-investing-greatest-bubble-ever-2017-6 http://www.businessinsider.com/steven-bregman-etfs-passive-i...
• icu 9y ago
  The more money that flows into index funds the more potential profit can be made by active managers. Vanguard themselves have research validating active managers. I'm not going to give you free advice (no two clients ever have the exact circumstances or requirements) but, as a financial adviser who has carefully weighed up the passive vs active approach for years, we advise our clients to invest in risk-targeted multi-manager multi-asset funds that we ourselves have done Due Diligence on which includes visiting their offices, talking to their management team and analysing their track record (all on a regular basis). I consider this best practice but I know of no other financial advisers that do this. I do recognise that this is most likely beyond what most private investors are capable of as we have millions worth of client money under advice which gets us in the door. I do think this, and our unique approach to delivering holistic financial advice is a core part of our unique selling proposition so there does come a point where it would be better to focus on your own way of making money and let an adviser focus on wealth preservation, tax optimisation and helping you create the life you want. As for the article, clients need to be responsible and look for chartered advisers who have advanced qualifications. In the UK this would be a FCA recognised Level 6 qualification and Chartered membership of the CII or CISI. In the United States, the Certified Financial Planner (CFP) is broadly comparable to Chartered status in the UK. Of course you could still get a bad adviser but the chances that someone who paid for, and studied for years, to gain Chartered status would throw their career away by not acting in a client's best interest would be extremely low.