Could Index Funds Be Bad? 1


In my prior posts, I spoke a lot about retirement as well as index funds.

There was a recent article in the Wall Street Journal blog titled “Are Index Funds Eating the World?

To be honest, this is kind of a click-bait title (as is mine)… but it worked. I was curious, so I read it.

I’d recommend you guys read it as well.


However, the long and short of it is:

The “secret” of index funds is out. 

“Over the past year, $310 billion has fled actively managed funds run by people who try (and often fail) to pick the best stocks and bonds. Meanwhile, $409 billion has poured into passive, or index, funds that seek to match the market rather than beat it.”  – WSJ Blog

I am not quite sure what has led to more people moving money out of actively managed funds and into passive index funds. However, I think the spread of knowledge (via the Internet) and education of the casual investor are most likely the proponents of this phenomenon. Now remember, passive investment using index funds is not a new idea.

Bogle started the First Index Investment Trust on December 31, 1975.

1975! So it has taken 30 years for this migration to occur. It’s like the snowball rolling down the hill, picking up speed, and gaining momentum. The switch took a long time to gain momentum. Bogle was “disappointed” that his index fund in 1975 only had $11 million in its first day August 31, 1976… he was hoping for it to have 10x that. However, slowly but sure, people have switched over.


Let’s get back to the question:

“Could Index Funds Be Bad?”

The idea that “too much of a good thing” is bad is an interesting one. There have been a few pieces of literature, which the article references warning against having too many people using index funds. This is an interesting question because There Ain’t No Such Thing As A Free Lunch. The idea of actively managed idea of you “win” which is opposed to the passive index funds is that you “win” by not playing .

The question is… what if everyone “doesn’t play”? The market depends on active investors to price it. If no one tries to figure out what something is worth… then what is it worth?


This is where it gets interesting:

Even Bogle himself, when asked ““What happens when everybody indexes?”, replied “Chaos, chaos without limit. You can’t buy or sell, there is no liquidity, there is no market.” –  WSJ Blog

Now wait just a second. Don’t go selling off all your index funds because “Senior Resident told you so”.

Bogle adds that indexing would have to be a huge majority of the market, probably more than 90% for the above to happen.

As for 2013, Index Funds were 18.4% of the market, but that has been rising steadily (linearly) since 2000 where it was only 9.5% of the market. A reasonable estimate for today is probably 20-25% of the market. However, it’s an interesting problem to have. Will we ever believe so much in indexing that we hit the 90% mark?

I doubt it.

Honestly, I doubt that indexing will ever even reach more than 50%. I think there will always be more people who think they can beat each other versus people who would rather stay the course.

Relevant Tweet via Owlturd

As long as competition exists in the world, there will always be people who try to win by doing.

Ok, ok, ok. You don’t like actively managed funds. I get it. But what if I wanted a small portion of my portfolio to be in an actively managed fund?

My question to you would be… why?

I’ll give you my answer in my next post on Actively Managed Funds (Gambling).


TL;DR

Index Funds are still the best way to handle things.

If we ever reach 90% indexing, chaos will ensue.

It’s an interesting question to have… but one I don’t think we need to worry about.

I’ll talk about Actively Managed Funds (Gambling) in my next post.

 

Also.. YAY, a short post! I did it!

-Sensei

Agree? Disagree? Questions, Comments and Suggestions are welcome.

You don’t need to fill out your email address, just write your name or nickname.

Share this:


Leave a comment

Your email address will not be published.

One thought on “Could Index Funds Be Bad?