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Comment by baron816 | Hacker News Reader

So clearly, for the individual, the optimal strategy is to simply invest in index funds and just wait.

But a new question that is being raised is: "what happens if everyone only invests in index funds?"

This has been answered a thousand times. Everyone will never invest in index funds. What will happen is more and more people will invest in index funds until there are so little people actively investing in the stock market that the ones that do are able to beat it. However, them beating it will only net (after their fees) the same returns as index funds thus striking a balance where index funds match the performance of active investors.

If either index funds or active investors (after fees) make more money, capital will move to the one that pays more until they balance again. We have had way too many active investors for a long time which is why index funds have constantly outperformed active investors but eventually they will balance as more and more people move their money to index funds.

How does the active part of the market beat the rest of the active part of the market? Like, I could see the net fees of the active funds being equal to the underperformance of "dumb money" retail investors mis-picking stocks.

I'm not exactly sure what you are saying. Are you asking how active investors in aggregate can beat index funds despite their fees?

Sorry. I'm asserting that active investors in aggregate own the exact same stocks in the same proportion as the fund that indexes the stocks they're picking from. So if one active investor outperforms the index, there has to be an active investor on the other side of their trades that has to underperform the index.

In other words, since the average active investor sets the average that passive indices track, how do they beat the average?

You can't assume that we'll reach equilibrium in a different future situation given that we're not in equilibrium at the moment.

You are missing the point. Once almost everyone invests in index funds, what will determine the price of stocks?

>>what will determine the price of stocks?

Do you think active investors determine the price of stocks now?

The active investors who are left of course.

> Once almost everyone invests in index funds, what will determine the price of stocks?

there are hundreds or thousands of index funds, all investing in different subsets of the market. money flowing back and forth between those funds will shift the relative value of their underlying sets.

also all the other answers, such as, that's unlikely to happen.

True with a caveat: they will never balance completely because of taxes and fees - active traders and funds will always underperform in aggregate.

I propose an ETF that invests in ETFs and active investors...

OR, since index funds are constantly getting 401(k) money dumped into them and therefore establish a reputation for a type of asset that has guaranteed returns with no risk, will develop into a massive asset bubble that will eventually go kablammo and take the retirement savings of half of the world down with them.

You have way too much faith in people making well informed decisions.

Matt Levine of Bloomberg has a newsletter called Money Stuff that talks about this concern a lot. There are certainly many serious people who take are worried that too much index based investing will / is leading to inefficiencies.

That column is really interesting and informative, I always check it out when he posts.

>> There are certainly many serious people who take are worried that too much index based investing will / is leading to inefficiencies.

It definitely is / will in the future, and they will be capitalized on. This isn't really a catastrophic event.

I don't think this is necessarily the case. I think if you're warren buffet, you should invest in index funds. If you're not warren buffet, this strategy runs the risk of being horrifyingly bad. For many people their job prospects may be procyclical - it's easier to get a job when the overall market is high and it's easier to get laid off when the overall market is in the pits. For these people, investing in index funds could lose money.

This gets back to time horizon and risk tolerance, which are independent of return.

These are two things you should think about when investing no matter what the vehicle is.

That never happens. There will always be people who want to be different from the herd. Any inefficiencies will take care of themselves.

>Any inefficiencies will take care of themselves.

Thats a ridiculous thing to say when the inefficiency here would represent your investments getting wiped out

making less money isnt the same thing as being whiped out.

This is the beauty of the capital markets. Shifting trends, money, assets from A to B will create new opportunities which will cause people to chase those - thus causing new trends and flows to emerge. So, I dont think we can ever get to a world where everyone moves all their chips into index funds.

get.out.of.the.equities.market.

this whole study is based on the equities market, and there are many many capital markets out there with much higher returns.

the individual? right, none of these markets are so optimal for retirement, they are optimal for great returns though

this study wasn't about the individual, it was about funds of funds that were picked pretty unoptimally and most likely were also in the equities market.

what is the individual to do? hey maybe your conclusion was right, but I don't find 85% over ten years to be great, even factoring in dollar cost averaging and dividend reinvesting. so there is the possibility for the individual to learn and take risk or find a fund that is more suited to the market you would like to get returns in.

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