4 ms·

The first two are sensible suggestions, but playing the stock market is essentially gambling. Most people would be better off investing in index funds.

dsacco 9y ago
I think the parent meant index funds. Index funds are the only kind of market participation that you can reasonably call "passive."
StavrosK 9y ago
I've recently heard doubts that index funds are a good investment. They're meant to be "investing in the US market", but aren't they really "investing in the Vanguard/whatever ETF"? Basically, doesn't the value of index funds reflect how much people think index funds will rise in value?
- conception 9y ago
  Index fund prices are tied to an index, hence the name. If the DOW goes up for a DOW index fund that fund will increase in value proportionally. Vanguard gets paid for managing the fund.
  - StavrosK 9y ago
    Ah, so the value of an ETF isn't what someone else is willing to pay for it, like a stock? EDIT: Apparently you can exchange the ETF for the underlying securities at any point, and vice versa, so the ETF's price can't diverge much.
    - encoderer 9y ago
      It's not so much that you can exchange a share of an ETF for micro-shares of the underlying security, but that the ETFs themselves keep their assets in the underlying and if it gets out of balance professional investors will short one side and go long the other and make the difference -- a form of arbitrage. Specifically, in the case of SPY, if the ETF was trading higher than the underlying, they would short the ETF and go long an appropriate number of shares of each of the 500 companies. The difference in the price is their profit. The very act of doing this brings the two prices inline and eventually you sell both sides and close the position for realized gains. Brokers let you do these transactions atomically. Of course, for transaction fees alone, this is not a strategy available to retail investors.
      - tanderson92 9y ago
        This is correct; Authorized Participants are the ones who exchange baskets of securities. It isn't really possible for individuals to exchange shares directly with the fund manager, but that's not an issue because the secondary market prices are kept reasonably close due to the professionals. The amount you can expect to lose relative to NAV (the actual value of your shares) is around half the bid-ask spread at the time you buy/sell. It also helps with tax efficiency since the creation/redemption process allows for shares with significant appreciation to be retired.
      - StavrosK 9y ago
        I see, thank you for the clarification.
- bobbington 9y ago
  Not really the ETFs are generally backed by the actual securities they represent. They may deviate from market value a bit intraday, but those deviations are picked up by special arbitrageurs and quickly eliminated. http://www.understandetfs.org/creation_redemption.html http://www.understandetfs.org/creation_redemption.html
  - StavrosK 9y ago
    Ah I see, thanks, I wasn't aware of that mechanism. So you can basically exchange the ETF for the actual held securities at any point, which keeps the price near that of the securities, pretty clever.
    - bobbington 9y ago
      I'm not sure that anyone can, but just that certain large entities can, and it is apparently profitable for them to do so, so they have incentive to keep it in line. If it's selling for less than it's worth, they will "cash out" at the end of the day and pick up the underlying shares at a discount. If it's selling for more than it's worth, they will buy more underlying securities and create new shares that sell for more than they are worth. I'm no expert though so it would be good to look into it more.
- tcbawo 9y ago
  The thought is that with index funds, you're invested in enough of the market that you don't have to pick winners and losers and you get rebalanced as well. It would be interesting to study the market cap effect of going from #501 to #500 in the S&P ratings. If you think the entire market is overbought, then they might not provide the best returns over the short term. However, most people are very bad at timing the market or picking the strongest companies that will thrive in a down market.
  - ksherlock 9y ago
    There S&P 500 is selected by a committee so there is no #501.
    - tanderson92 9y ago
      Technically there are 505 due to dual-share classes for 5 of the securities in the index.
    - tcbawo 9y ago
      My point is that there is probably a bump going in and a hit falling out. This wikipedia article (https://en.wikipedia.org/wiki/List_of_S%26P_500_companies https://en.wikipedia.org/wiki/List_of_S%26P_500_companies) shows the additions and removals. I am curious about the distortive effects of demand from the S&P 500 as a proxy for the effects of passive investing.

dsacco 9y ago

I think the parent meant index funds. Index funds are the only kind of market participation that you can reasonably call "passive."

StavrosK 9y ago

I've recently heard doubts that index funds are a good investment. They're meant to be "investing in the US market", but aren't they really "investing in the Vanguard/whatever ETF"? Basically, doesn't the value of index funds reflect how much people think index funds will rise in value?

conception 9y ago
Index fund prices are tied to an index, hence the name. If the DOW goes up for a DOW index fund that fund will increase in value proportionally. Vanguard gets paid for managing the fund.
- StavrosK 9y ago
  Ah, so the value of an ETF isn't what someone else is willing to pay for it, like a stock? EDIT: Apparently you can exchange the ETF for the underlying securities at any point, and vice versa, so the ETF's price can't diverge much.
  - encoderer 9y ago
    It's not so much that you can exchange a share of an ETF for micro-shares of the underlying security, but that the ETFs themselves keep their assets in the underlying and if it gets out of balance professional investors will short one side and go long the other and make the difference -- a form of arbitrage. Specifically, in the case of SPY, if the ETF was trading higher than the underlying, they would short the ETF and go long an appropriate number of shares of each of the 500 companies. The difference in the price is their profit. The very act of doing this brings the two prices inline and eventually you sell both sides and close the position for realized gains. Brokers let you do these transactions atomically. Of course, for transaction fees alone, this is not a strategy available to retail investors.
    - tanderson92 9y ago
      This is correct; Authorized Participants are the ones who exchange baskets of securities. It isn't really possible for individuals to exchange shares directly with the fund manager, but that's not an issue because the secondary market prices are kept reasonably close due to the professionals. The amount you can expect to lose relative to NAV (the actual value of your shares) is around half the bid-ask spread at the time you buy/sell. It also helps with tax efficiency since the creation/redemption process allows for shares with significant appreciation to be retired.
    - StavrosK 9y ago
      I see, thank you for the clarification.
bobbington 9y ago
Not really the ETFs are generally backed by the actual securities they represent. They may deviate from market value a bit intraday, but those deviations are picked up by special arbitrageurs and quickly eliminated. http://www.understandetfs.org/creation_redemption.html http://www.understandetfs.org/creation_redemption.html
- StavrosK 9y ago
  Ah I see, thanks, I wasn't aware of that mechanism. So you can basically exchange the ETF for the actual held securities at any point, which keeps the price near that of the securities, pretty clever.
  - bobbington 9y ago
    I'm not sure that anyone can, but just that certain large entities can, and it is apparently profitable for them to do so, so they have incentive to keep it in line. If it's selling for less than it's worth, they will "cash out" at the end of the day and pick up the underlying shares at a discount. If it's selling for more than it's worth, they will buy more underlying securities and create new shares that sell for more than they are worth. I'm no expert though so it would be good to look into it more.
tcbawo 9y ago
The thought is that with index funds, you're invested in enough of the market that you don't have to pick winners and losers and you get rebalanced as well. It would be interesting to study the market cap effect of going from #501 to #500 in the S&P ratings. If you think the entire market is overbought, then they might not provide the best returns over the short term. However, most people are very bad at timing the market or picking the strongest companies that will thrive in a down market.
- ksherlock 9y ago
  There S&P 500 is selected by a committee so there is no #501.
  - tanderson92 9y ago
    Technically there are 505 due to dual-share classes for 5 of the securities in the index.
  - tcbawo 9y ago
    My point is that there is probably a bump going in and a hit falling out. This wikipedia article (https://en.wikipedia.org/wiki/List_of_S%26P_500_companies https://en.wikipedia.org/wiki/List_of_S%26P_500_companies) shows the additions and removals. I am curious about the distortive effects of demand from the S&P 500 as a proxy for the effects of passive investing.