> And the bigger indices grow, the larger the opportunities for active traders to profit. It's not a real problem — it's self-correcting.
I appreciate that finally someone puts forward a rational argument as to why index fonds will keep working. Books and online resources tend to not take a critical look at the system at all or they offer an answer along the lines of "Trust me!"
Having said that, only hindsight is 20/20! It feels like we are rushing into the next great financial experiment. In a complex world there is simply no telling what's actually going to happen. I assume (any sources?) that currently more money than ever is flowing into index fonds. Furthermore, chances are this is just the beginning. For instance, the buy-and-hold hype is just arriving in Europe. Blogs and online communites on this topic are currently mushrooming here! Yesterday I even saw an ad on Germany's biggest TV station right before the evening news. This is very unusual to say the least as the common people of Germany by and large have an incredible amount of distrust in anything but savings books! This current gold rush mood is just scary to me as usually, when something hits mainstream media, the magic is gone!
Anyhow, the question I am asking myself is: What will the market do now that it has access to more cash than ever? Are the markets even productive enough to put those sums of money to good use? Or is this bonanza just FU-money that encourages more reckless behavior?
I can only speculate as to what is going to happen but my hunch is that in the long term the gap between returns from index fonds and savings books is going to become a great deal smaller as more people are willing to shoulder risk for companies and thus risk premiums go down. There may still be active traders who try to find opportunities but I suspect structurally the percentage of passive investors will expand quickly and won't go back below today's percentage.
You're talking as if there's a swarm of fresh money flowing into the market, whereas it's more a case of people shifting away from traditional actively managed mutual funds etc. into indexing.
Money is cheap at the moment because growth is low, and that in turn means risk premia are lower and so on, but I don't think that's related to the rise of index funds. Then again I never understood why active management was so popular in the first place.
> You're talking as if there's a swarm of fresh money flowing into the market, whereas it's more a case of people shifting away from traditional actively managed mutual funds etc. into indexing.
Yeah, the question seems to be about fresh money. You could be right that we are mostly witnessing a shift from actively managed funds to indexing. As far as my home country (Germany) is concerned indexing seems to become more attractive to people who never invested, though. Now that I think about it I am not sure whether or not this kind of money would be "fresh money" as these people stored their money in banks who were probably investing it.
> Money is cheap at the moment because growth is low, and that in turn means resk premia are lower and so on, but I don't think that's related to the rise of index funds. Then again I never understood why active management was so popular in the first place.
As I understand it, risk premia is not related to growth. It is simply the costs to transfer risk to someone else. Active management was probably high in the past as banks had little incentive to sell passive investment plans: If people don't constantly buy and sell they don't cause transaction costs and thus income for the bank. Active and passive management are both neither inherently wrong or right. Until now active investment has been irrational but it could theoretically change if the share of money passively invested is high enough, say (made up number incoming) 80%.
> As I understand it, risk premia is not related to growth. It is simply the costs to transfer risk to someone else.
My point was that investors targeting a particular rate of return are having to take on more risk (because growth is low), which in turn lowers the risk premium through ordinary supply and demand.
"Money is cheap at the moment because growth is low, and that in turn means risk premia are lower and so on"
Maybe. Money is cheap if you are a bank or a government backed borrower (like a conforming mortgage loan in the US).
If you have collateral, like the car you're borrowing against, money is kind of cheap ... also if you have a perfect credit history.
But I am not so sure that money is cheap right now out in the real world. If you are a new business with no track record or a consumer with poor credit history I think money might be quite expensive for you ...
> But I am not so sure that money is cheap right now out in the real world. If you are a new business with no track record or a consumer with poor credit history I think money might be quite expensive for you ...
Really? My understanding was that (non-mortgage) subprime lending was higher than ever, business loans were cheaper than ever...
I can only speculate as to what is going to happen but my hunch is that in the long term the gap between returns from index fonds and savings books is going to become a great deal smaller as more people are willing to shoulder risk for companies and thus risk premiums go down
Doesn't that suggest people on average have had a misplaced fear of stock (indices) in the past, and that capital is now more efficiently allocated? Sounds like it would make the world better off.
> Doesn't that suggest people on average have had a misplaced fear of stock (indices) in the past.
Yes, I think this bit is pretty much agreed upon today. Hence the run for indices.
> and that capital is now more efficiently allocated?
That sounds likely to me.
> Sounds like it would make the world better off.
As tempting as it is to argue one way or another ... I think that's an impossible statement to make.
But like I initially said, it's all just speculation anyhow. Tbh these kind of discussions are inherently whacky. Chances are everything you've quoted from me is flawed on so many levels if one takes a closer look.
Discussing finance is mostly a fool's errand.
I appreciate that finally someone puts forward a rational argument as to why index fonds will keep working. Books and online resources tend to not take a critical look at the system at all or they offer an answer along the lines of "Trust me!"
Having said that, only hindsight is 20/20! It feels like we are rushing into the next great financial experiment. In a complex world there is simply no telling what's actually going to happen. I assume (any sources?) that currently more money than ever is flowing into index fonds. Furthermore, chances are this is just the beginning. For instance, the buy-and-hold hype is just arriving in Europe. Blogs and online communites on this topic are currently mushrooming here! Yesterday I even saw an ad on Germany's biggest TV station right before the evening news. This is very unusual to say the least as the common people of Germany by and large have an incredible amount of distrust in anything but savings books! This current gold rush mood is just scary to me as usually, when something hits mainstream media, the magic is gone!
Anyhow, the question I am asking myself is: What will the market do now that it has access to more cash than ever? Are the markets even productive enough to put those sums of money to good use? Or is this bonanza just FU-money that encourages more reckless behavior?
I can only speculate as to what is going to happen but my hunch is that in the long term the gap between returns from index fonds and savings books is going to become a great deal smaller as more people are willing to shoulder risk for companies and thus risk premiums go down. There may still be active traders who try to find opportunities but I suspect structurally the percentage of passive investors will expand quickly and won't go back below today's percentage.