Worth noting that articles about how passive investing destroys the market date back to, maybe, 2016 or earlier...<p><a href="https://www.newyorker.com/business/currency/is-passive-investment-actively-hurting-the-economy" rel="nofollow">https://www.newyorker.com/business/currency/is-passive-inves...</a><p>March 9, 2016<p>> O’Neill fears that the result will be a “bubble machine”—a winner-take-all system that inflates already large companies, blind to whether they’re actually selling more widgets or generating bigger profits.<p>Part of the problem is that if you look at the stellar long-term performance of indexes, they are largely explained by a small number of stocks in the index that perform extremely well… but you don’t know ahead of time which stocks those are. If you want the performance of the S&P500, you need a similarly diversified portfolio, the theory goes. It is hard to get a portfolio with that kind of diversity unless you buy index funds.
That diversification is a bit of a smoke-screen though. The most popular index funds are cap-weighted. This causes the allocation of capital within the fund to become increasingly dominated by those few winner-take-all companies.<p>When index funds grow to huge levels of assets under management, their own asset allocations come to make up a significant portion of the market cap of the stocks in the portfolio. Thus the cap-weighted investment strategy becomes a self-fulfilling prophecy.
> Thus the cap-weighted investment strategy becomes a self-fulfilling prophecy.<p>Either you’re doing the math wrong or you’ve skipped some steps.<p>Let’s say you have companies X and Y, each with 50% of the market. X is a winner, and the stock price goes from $10 to $45. Y is a loser, and the stock price drops from $10 to $5. The new weight is X=90% and Y=10%.<p>But this cannot be a self-fulfilling prophecy for index funds, because the index funds do not have to buy or sell any shares of X or Y to keep up (I mean rebalance, specifically). In this scenario, the index funds are just holding. (By “holding” I mean “not rebalancing”.)<p>This is… an oversimplified scenario. But it illustrates the problem here with the “index funds cause a small number of stocks to be winners” theory. There are alternative theories that make sense, but not this one.<p>(What makes the scenario more complicated is when you think of buybacks, dividends, delisting, etc.)
Don't index funds trail market changes though? I thought their allocations are reactive. In other words, the Mag 7 are being bid up by people trying to beat the market. I don't see how index funds could move prices.<p>I do understand how they can stabilize allocations where they are, which I think is the concern. Zombification rather than a positive feedback loop.
IIRC a huge chunk of the returns comes from roughly 4% of all stocks while the rest is basically (very simplified) just earning their cost of capital.
And anyone who thinks they can consistently predict who will be among the 4% is... mistaken. Diversification is how one manages risk when a system has a power law distribution of outcomes.<p>Trying to beat the market is playing a zero sum game. Someone has to lose for you to win. I understand savvy winners add information, but most winners are just lucky and it still makes me uneasy to play a zero sum game.<p>When you simply try to match the market, you float on the tide that mostly raises all boats and sometimes lowers them. That sits much better with me.
Yes, my understanding is that the cost of missing out on those companies that are providing the returns is much more costly than investing in a company that is NOT generating those returns.<p>In other words, the risk is to miss the winners, not that you will invest in a loser.<p>The problem is that it is very hard to predict the winners, so it is best to invest in all companies to make sure you have the winners
I saw the underlying theory discussed years ago, in a series of articles on a very serious economics blog, coming to very different conclusions:<p><a href="https://www.philosophicaleconomics.com/2016/05/passive/" rel="nofollow">https://www.philosophicaleconomics.com/2016/05/passive/</a><p><a href="https://www.philosophicaleconomics.com/2016/05/followup/" rel="nofollow">https://www.philosophicaleconomics.com/2016/05/followup/</a><p><a href="https://www.philosophicaleconomics.com/2016/05/indexville/" rel="nofollow">https://www.philosophicaleconomics.com/2016/05/indexville/</a><p><a href="https://www.philosophicaleconomics.com/2016/05/passiveactive/" rel="nofollow">https://www.philosophicaleconomics.com/2016/05/passiveactive...</a><p>Looks like the blog stopped in 2020, unfortunate....
This is like travel agents crying that websites like TripAdvisor destroyed tourism. Not exactly an impartial party, so it's hard to take them seriously even if the point makes sense.<p>"I used to keep this gate, and now it's all ruined!"
Hasn't Michael Burry been talking about this exact thing for at least 6 years now?<p>Edit:<p>The Big Short’s Michael Burry Explains Why Index Funds Are Like Subprime CDOs (2019)<p><a href="https://archive.is/7mOuF" rel="nofollow">https://archive.is/7mOuF</a>
Here’s the thing about stock markets: if you think it’s inflated or there’s a bubble, great, you can pull your money out. But then you look around and try to figure out a better place to put your money long term, and where does that bring you?<p>Back to the stock market.
What is this supposed to mean? Yes, people are unhappy with the choice of "high risk of losing 1/2 of your savings at an inopportune moment" and "watch it all decay away thanks to our inherently inflationary regime".
> high risk of losing 1/2 of your savings at an inopportune moment<p>Operative word being <i>moment</i>. The volatility is irrelevant if you wait it out long enough, hence "long term". If you need a shorter term low-risk investment vehicle, that's what treasury bills/notes are for.<p>> watch it all decay away thanks to our inherently inflationary regime<p>Any alternative investment strategy is equally affected by inflation.
These days canned food often seems like a good investment
> Back to the stock market.<p>It’s a very different calculus when nominal bonds are paying 5% and TIPS are paying 2.6% above inflation.<p>The nowhere to go but the stocks holds more water when the ten year was paying 0.55%.
If you think it will go down you can short the market.<p>If you think it will go up just more slowly well that’s hardly all that bad?
Is this the answer for citizens of countries other than America? I don't think it is.
You say that like “stock market” = the US stock market.<p>It doesn’t. And the smart money recognized this a couple years ago. You’ve been presented with a false dichotomy.
If we judge it by the lost decade after the 2000 tech bubble definitely not back to stocks.<p>A portfolio of things like gold, small cap value, long term treasuries did 10% a year while stocks did like 0% a year for a decade.<p><a href="https://portfoliocharts.com/2021/12/16/three-secret-ingredients-of-the-most-efficient-portfolios/" rel="nofollow">https://portfoliocharts.com/2021/12/16/three-secret-ingredie...</a>
Active management funds are more than welcome to beat or keep pace with the market consistently for 45 years. Until then, I'll choose the winning option.
Tax breaks for people who already have more money then they can spend fuel bubbles. It makes number go up even when the economic fundamentals are in the toilet.
Yes. If I have more money than I can spend I take a risk and invest that money in a company that has a productive use for that money. They hire people, do research, produce products and return the profits to me, the person who took a risk.<p>It's not a conspiracy.
The giant rise and fall of Oracle in 2025 would suggest that price discovery is alive and well for megacaps, and there is money to be made by being smart about (if you have sufficient scale for research)<p><a href="https://www.google.com/finance/beta/quote/ORCL:NYSE?window=1Y" rel="nofollow">https://www.google.com/finance/beta/quote/ORCL:NYSE?window=1...</a>
The traditional historical PE ratio of ~17 was before it was so easy to invest in the stock market. PAssive or not.<p>The current SP500 pe ratio is ~31<p>It's not unreasonable to expect that this might even be below the new average whatever that might be. In fact, the antistock market like gold/silver/bitcoin is also probably low; not high.<p>Even if 17 is still the correct number, 31 isnt even a bubble by definition.
<a href="https://archive.is/ppHt0" rel="nofollow">https://archive.is/ppHt0</a><p>Paper this article is based on (2021): <a href="https://www.nber.org/system/files/working_papers/w28967/w28967.pdf" rel="nofollow">https://www.nber.org/system/files/working_papers/w28967/w289...</a>
Remember the 2008 subprime mortgage crisis, famously caused by passive investors buying CDOs through their Vanguard funds? Or the dotcom bubble? The great depression? Remember when passive investors were buying tulip ETFs in the 1600s?<p>You don't, because every single financial bubble in history has been caused by <i>active</i> investors speculating and gambling, in most cases with other people's money. And now that people want to stop giving them money (and the associated fees) they turn around and go "you don't know what you are doing, you'll totally cause a bubble". Give me a break.
Calling everything a "bubble" without identifying where capital would rationally go instead is lazy analysis. I've been an investor for 15 years and every single year someone screams we're in a bubble. It never ends
It’s only a matter of time until people start to wake up to the fact that gold’s 5 year return is almost double the US markets and the developed nation index has doubled the US market returns in the last year.<p>Capital has been FLEEING the US for some time now. Passive investments aren’t inflating a bubble. They’re providing exit liquidity to smart money.
<i>"Their indiscriminate buying could therefore pull share prices out of whack with underlying earnings. Pulling in the opposite direction are the arbitrageurs, such as hedge funds, which can take the other side of tracker funds’ trades and profit from bringing prices back into line with fundamentals."</i>
Is printing money inflating stockmarket and every other price?
CNBC had a guest on the show who revealed that passive investment like index etf is destroying price discovery in the market.
Instead of "passive" one could call it "blind" investing. Just dumping money broadly into the marker via 401k contributions. When retirees pulling out exceeds those putting in it will all be over.