If you're saying that the novices are just bad investors who always buy at the wrong time then I'd want a little more evidence of that. My base assumption is that the novices do not have predictive power and are simply "noise traders".
Note that I'm not expressing a view on the market in this comment.
This means that with less than $1000, you can own a representation of the S&P500, weighted by market cap, either through ETFs or mutual funds. Weighted by market cap means that you're putting a larger percentage of that $1000 into the bigger companies, versus the smaller companies.
When a few companies start to dominate the market, everyone can be overweight a few stocks in the same way, and not even know it.
https://www.cnbc.com/2017/05/17/four-tech-heavyweights-make-...
If company A is worth 10x what company B is worth then I can buy 10x of company A and 1x of company B to spread my impact as evenly as possible.
The minimal impact of cap weighting is actually that you don't have to rebalance your investments to keep them tracking the same. By them going up and down, they keep the same percentage by market cap weight.
What you seem to be saying is good is diversification, which it is, but you have to make sure you are well diversified.
Can you explain how this works?
Suppose Company A is worth $100 billion and Company B is worth $10 billion. Buying $100 of Company A and buying $10 of Company B shouldn't push up the price of Company A faster than Company B. You're buying 0.0000001% of each company so you'd expect that you'd push up the price of both companies at the same rate.
> The minimal impact of cap weighting is actually that you don't have to rebalance your investments to keep them tracking the same. By them going up and down, they keep the same percentage by market cap weight.
Yes this is another benefit of cap weighting.
Sorry, you're totally right. The prices should increase in the same weighting when buying just like they go down in the same when selling.
The difference is that you're weighted by market caps, so you're increasing the P/E of the entire market (in a super small way). That is, you're not investing more in companies that are valued more "attractively" (lower P/E multiple) than those that might be "over valued" (high P/E), which is what the market typically does to determine prices.
I'm not sure I agree that low P/E means that a stock is undervalued. For example a company that is guaranteed to make $10 every year should probably have a higher P/E than a company that is expected to make $10 with $1 variance.
If we move to a more abstract notion of undervalued then I still agree with you that cap-weighting isn't guaranteed to overweight the undervalued stocks.
Not necessarily. The price could change in VERY different ways depending on the marginal supply and demand for each stock (i.e., how many more/fewer shares of the stock are other investors willing to buy/sell at different prices when the index fund goes out to buy that 0.0000001% of float). A tiny 'buyer-seller imbalance' in the stock market cause a big price adjustment.
Of course, that's little consolation for those who lose out during the correction period - so your point stands. But AFAIK we're well below the danger zone for too much public market capital being passively indexed.
Given how the central banks act, this affects the currency markets and interest rates.
(1) https://asia.nikkei.com/Markets/Equities/Japan-s-central-ban...
(2) http://www.businessinsider.com/swiss-national-bank-owns-80-b...