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This is a real misunderstanding of how markets work. An index fund invests in everything, market-cap weighted (usually). This means that your investment merely

by darawk 8y ago

This is a real misunderstanding of how markets work. An index fund invests in everything, market-cap weighted (usually). This means that your investment merely reinforces the prices already determined by the other participants in the market. There are still huge numbers of active managers, not to mention quants and others. They, collectively, determine the prices of assets. When you invest in an index fund, you're just saying "I'll have what they're having", basically. It doesn't cause amazon to rise in price. Lots of companies are in the S&P 500, they don't have returns like Amazon does. Amazon has those returns because people allocate capital specifically to them, i.e. non-index investors. > And by we, we mean the fat cats who are taking in that investment money you're giving us. You'll make a meager return, but we'll make oh so much more. Index funds are the least fat-cat-remunerating route you have available to you. They have lower expense ratios than you'd be able to achieve on your own, unless you're using a free service like Robinhood (and if you do that, you're probably paying in other ways, like poorer execution prices).

toss1 8y ago
> basically. It doesn't cause amazon to rise in price. Actually, it does. Whenever a company is added to one of the major indexes, it almost always increases in price, and conversely, when one is removed, it generally declines. This is specifically because of all of the index funds that suddenly must put money into/remove it from the stock when it is added/removed from the index. Supply, Demand, price curves, you know the rest ...
- crazygringo 8y ago
  But are those short-term artifacts or do they persist? As long as stock prices are set fundamentally by deep-pocketed institutional investors buying and selling, a stock's price should only be based on expected discounted future cash flows, no? I can understand a short-term effect if demand suddenly skyrockets, but that can only last a few days, no? I'm struggling to reconcile traditional supply/demand with the efficient-market hypothesis here.
- darawk 8y ago
  Yes, but it impacts everyone in the index equally. Index funds are not responsible for amazon in particular's performance.
  - toss1 8y ago
    around the time they add/remove Amazon (or company X) to the index, they do enhance or detract from it's performance. Of course, when't it's there for years, it merely adds a relatively steady-state chunk to their price, affecting the level of their price curve, but not so much the slope.
    - darawk 8y ago
      Yep, true. My point is just that indexing has nothing to do with Amazon's meteoric rise. Nor does it make the market less efficient or any other such nonsense.
      - toss1 8y ago
        Yes, I'd guess the effect in the single-digit percentages, and being in the index didn't help GE not get dumped. Interesting question about market inefficiencies. Again, while they're not zero, I'd guesstimate them to be in the minor percentages... If Amazon suddenly adjusts their R&D spend to show the massive profit of which they're capable, or does a massive increase to go after a new market, I'd expect it to go up or down massively more than the index and drag the index along. In that respect, the index may play a dampening effect, as people invested in index funds just go along for the general index ride instead of jumping on/off the AMZN bandwagon.
        darawk 8y ago
        Ya, if I had to guess at an effect I think that'd be it too. It ought to dampen hysteria, by keeping retail investors out of the market for the most part.
djrogers 8y ago
> basically. It doesn't cause amazon to rise in price. Yes, it does - you cannot add capital to a market without raising the market cap. It doesn't cause it to raise higher or faster than it's index peers, but it absolutely does cause it to rise.
- darawk 8y ago
  It doesn't cause it to rise in price relative to others in the same index.
  - cm2187 8y ago
    But these strategies do have all sorts of side effects on the market. It pushes the correlation between stocks up. Investors might be more hot handed as their investment is more liquid, which may result in more selling in a dip. There are all sort of algorithmic strategies that are pro-cyclical. And also it reduces discrimination between stocks which results in weaker stocks benefiting from just being in the index and being overpriced.
    - darawk 8y ago
      > It pushes the correlation between stocks up. Citation needed. I seriously doubt that this is true. > And also it reduces discrimination between stocks which results in weaker stocks benefiting from just being in the index and being overpriced. Not really. Retail investors allocating their money to index funds just leaves the price-setting power to the professionals, which, on net, ought to be better for price discovery anyway.
      - cm2187 8y ago
        First result on google: https://www.bloomberg.com/news/articles/2018-09-09/asia-stocks-point-to-drop-dollar-holds-advance-markets-wrap https://www.bloomberg.com/news/articles/2018-09-09/asia-stoc... But it is kind of intuitive anyway. ETFs are becoming significant in volumes, so when net volumes buy or sell them, they force the sponsor to buy/sell the whole market reducing price discrimination. To have any price setting power you need large volumes.
camjohnson26 8y ago
You're saying that an increase in demand won't increase the price. Obviously there are other factors that affect the price too but being in an index fund is absolutely one of them.
- darawk 8y ago
  No, I am saying that that same demand impacts everyone in the index equally. That's the point of an index fund.
megaremote 8y ago
This is true, but it also means that they don't fall as much. No matter what the results, the index funds will not sell, so it means the market doesn't change as much.
- darawk 8y ago
  That's sort of true, but it's an over-simplification. People with capital and conviction can still short heavily. What it does is dampen the emotional swings of retail investors. So, for the market as a whole, volatility should go down as indexing becomes more popular.

by darawk 8y ago

toss1 8y ago

> basically. It doesn't cause amazon to rise in price. Actually, it does. Whenever a company is added to one of the major indexes, it almost always increases in price, and conversely, when one is removed, it generally declines. This is specifically because of all of the index funds that suddenly must put money into/remove it from the stock when it is added/removed from the index. Supply, Demand, price curves, you know the rest ...

crazygringo 8y ago
But are those short-term artifacts or do they persist? As long as stock prices are set fundamentally by deep-pocketed institutional investors buying and selling, a stock's price should only be based on expected discounted future cash flows, no? I can understand a short-term effect if demand suddenly skyrockets, but that can only last a few days, no? I'm struggling to reconcile traditional supply/demand with the efficient-market hypothesis here.
darawk 8y ago
Yes, but it impacts everyone in the index equally. Index funds are not responsible for amazon in particular's performance.
- toss1 8y ago
  around the time they add/remove Amazon (or company X) to the index, they do enhance or detract from it's performance. Of course, when't it's there for years, it merely adds a relatively steady-state chunk to their price, affecting the level of their price curve, but not so much the slope.
  - darawk 8y ago
    Yep, true. My point is just that indexing has nothing to do with Amazon's meteoric rise. Nor does it make the market less efficient or any other such nonsense.
    - toss1 8y ago
      Yes, I'd guess the effect in the single-digit percentages, and being in the index didn't help GE not get dumped. Interesting question about market inefficiencies. Again, while they're not zero, I'd guesstimate them to be in the minor percentages... If Amazon suddenly adjusts their R&D spend to show the massive profit of which they're capable, or does a massive increase to go after a new market, I'd expect it to go up or down massively more than the index and drag the index along. In that respect, the index may play a dampening effect, as people invested in index funds just go along for the general index ride instead of jumping on/off the AMZN bandwagon.
      - darawk 8y ago
        Ya, if I had to guess at an effect I think that'd be it too. It ought to dampen hysteria, by keeping retail investors out of the market for the most part.

djrogers 8y ago

> basically. It doesn't cause amazon to rise in price. Yes, it does - you cannot add capital to a market without raising the market cap. It doesn't cause it to raise higher or faster than it's index peers, but it absolutely does cause it to rise.

darawk 8y ago
It doesn't cause it to rise in price relative to others in the same index.
- cm2187 8y ago
  But these strategies do have all sorts of side effects on the market. It pushes the correlation between stocks up. Investors might be more hot handed as their investment is more liquid, which may result in more selling in a dip. There are all sort of algorithmic strategies that are pro-cyclical. And also it reduces discrimination between stocks which results in weaker stocks benefiting from just being in the index and being overpriced.
  - darawk 8y ago
    > It pushes the correlation between stocks up. Citation needed. I seriously doubt that this is true. > And also it reduces discrimination between stocks which results in weaker stocks benefiting from just being in the index and being overpriced. Not really. Retail investors allocating their money to index funds just leaves the price-setting power to the professionals, which, on net, ought to be better for price discovery anyway.
    - cm2187 8y ago
      First result on google: https://www.bloomberg.com/news/articles/2018-09-09/asia-stocks-point-to-drop-dollar-holds-advance-markets-wrap https://www.bloomberg.com/news/articles/2018-09-09/asia-stoc... But it is kind of intuitive anyway. ETFs are becoming significant in volumes, so when net volumes buy or sell them, they force the sponsor to buy/sell the whole market reducing price discrimination. To have any price setting power you need large volumes.

camjohnson26 8y ago

You're saying that an increase in demand won't increase the price. Obviously there are other factors that affect the price too but being in an index fund is absolutely one of them.

darawk 8y ago
No, I am saying that that same demand impacts everyone in the index equally. That's the point of an index fund.

megaremote 8y ago

This is true, but it also means that they don't fall as much. No matter what the results, the index funds will not sell, so it means the market doesn't change as much.

darawk 8y ago
That's sort of true, but it's an over-simplification. People with capital and conviction can still short heavily. What it does is dampen the emotional swings of retail investors. So, for the market as a whole, volatility should go down as indexing becomes more popular.