Risk of broad index investing

Investing / Portfolios
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Hi there
I’ve been a reader for quite some time but haven’t posted anything myself so far (partially because my English isn’t all that fluent…). I’m a 41yrs old, self-employed gp (family doctor) in the Germanspeaking part of Switzerland and have a daughter of 6 yrs. Since her dad doesn’t live with us I can’t work as much as I want to but thanks to my job I’m still able to make some nice figures and put a good amount of money aside. I’ve been investing in indexes, have some gold and had some BTC for several years, besides my 3a fully in stocks and a half-full pension fund (with a gap of about 100k atm)
so what I was actually going to ask you guys:

  • what do you think of the risk of broad index investing like moving all the money to the big companies (as soon as a company makes it on the index they will get a huge influx of money), changing the decision making when there are mainly companies like Blackrock / Vanguard and others holding voting rights, and the reduction of market efficiency with less investors actively analyzing the market?
    I’m interested in you guys opinion since I really appreciate this forum. I unfortunately don’t have many friends who are interested in finances (how could you not?) and most of my doctor colleagues leave all financial decisions to their bancers
    Kind regards and a nice day to all of you!

Judith

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Welcome!

I’m putting on my beekeeper’s mask & suit since you just stirred with a stick the hornet nest of passionate index investors … :wink:

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You might want to catch up some lingo :slight_smile: sharing a debate from both sides

Crash course on the topic

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I would say

Gerd Kommer
Souverän investieren mit Indexfonds und ETFs

Is a classic book about investing in German.

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I don‘t think that this statement is true. The market could even get more efficient by removing all the random traders.

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This is a very complicated question to unpack and answer in a good way. A few spot answers:

  • A company doesn’t get your money at the moment, or any other moment since they joined an index, they get money at IPO, after that it’s people and institutions trading the stocks
  • a company joining an index means the funds/managers following the index need to add it, which means selling + buying and potential creating hidden losses/costs shareholders of their index fund, interesting case study of Tesla, essentially the fund managers for S&P500 ETFs and mutual funds had to sell low, buy high…
  • Fund managers like Vanguard and Blackrock may (and do) vote, and that’s a problem, but not one I care about
  • the balance between active and passive investors and market efficiency has been studied a lot, the top top top line findings are that active investing finding or creating inefficiency is not only desired, but needed for the market to…remain efficient (every inefficiency found is exploited, and thus corrected!).
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To add a small point: Buying a very broad ETF (e.g. VTI or VT) mitigates a bit against the “buy high sell low” that can occur with S&P500 company inclusions. Broader indexes contain the company already.

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I also always wondered what are the limits of passive investing in the broader economy. How much money can it absorbs before it starts distording markets ? It must give stocks more momentum when they are added/removed from these indices. And conversely, prices are much more stickier when most of the investor base is passive.

For younger people, broad equities ETF is becoming the primary store a value, it’s just gonna keep growing. It’s playing the role of what real estate was for prior generations. Unfortunately, RE has become too expensive for millennials to afford it + their life and careers are too unpredictable to stay in one place anyway.

This isn’t a personal finance discussion. At the individual level, there are still no better solutions than ETFs. But I worry that it is one of those things that someday might stop working when everyone else is doing it. I’d be curious to read some research on the topic.

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I think the starting point should always be a broadly diversified index fund.

If you feel like you are smarter than the market you can tilt slightly by adding certain positions.

But be honest to yourself, why should you be smarter than the market if there are large investment firms with highly paid people working long hours to squeeze out some basis points of outperformance?

I think there is enough smart capital and highly leveraged products to make the market, especially large cap developed markets, sufficiently efficient. I am not aware of any scientific findings that would indicate otherwise

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