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Comment by baby | Hacker News Reader

I'm a noob in investing so I have a few questions:

* Is this a bad news?

* Are there index funds that blindly follow the top 500 but actively remove dumb stocks?

* Should I avoid American-only index fund? Looks like the Chinese market is becoming pretty strong and there doesn't seem to be any insurance that the American market will stay as strong in the next 20+ years. I would comfortable betting on the world market, but not really on one country's market.

* I have some money saved up that I don't know what to do with. I'll probably look into investing for an apartment in the next 2-5 years. Should I let it sit in my bank account or should I put everything in an index fund?

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I'm surprised lot of people here think this is not bad news. It most certainly is. Think about it: Index funds don't make any moves by themselves, they simply follow the aggregate decision of active investors that are still in market. This is all good when they have < 50% share but above that now there is more asset that follows smaller assets.

Consider the extreme example: Let's say 99.999999% of assets are in index funds and now there are basically only 10 people left in market who are doing active investing. So when these 10 people decides to sell stock of some company, that stock will fall by some minor amount but immediately all index funds would need to react to this minor drop and sell their holdings. But that would cause more market drop and price would take a death spiral route. This basically means that those 10 people now left to do active investment can now control the market. Any of their small movements gets amplified by large gorillas of index funds.

Above is just tip of the iceburg. The secret of the success of index funds has been very simple: They aggregate all the active investors and these average turns out to be better than individual. However when number of active investors reduces, the variance would increase and this means index funds would become less and less optimal over time.

I see, indeed IIUC index funds can stagnate and do not provide movement (up or down) on the market. So they are basically neutral when it comes to influencing trends. On the other hand, if the lack of active actors on the market means that the market is only going down, it would be inconsistent.

Seems a little hyperbolic.

As active investors are basing their decisions on p/e ratios and EBITDA then algorithmic choices can substitute for the lack of human traders.

In fact, traders are the ones who should be worried about AI, not taxi drivers. We're going to need a lot less traders and more data scientists.

> So when these 10 people decides to sell stock of some company, that stock will fall by some minor amount but immediately all index funds would need to react to this minor drop and sell their holdings.

That's not how it would work.

1) When one of the 10 sells they must be selling to another of the 10 who is buying. There's no such thing as just selling. Instead the way that the price would drop would be that the 10 start trading that stock between themselves at a lower price than it had been before.

2) If the price dropped then that wouldn't mean that the index fund had to sell. The index fund aims to own a fixed proportion of each company. If they own $98 million of a $100 million company and then the share price drops in half then they now own $49 million of a $50 million company. There's no need for them to do anything.

1) few parties can collude to sell or buy at the price they desire.

2) Index fund must balance their portfolio. If stock A goes down and B goes up then they must sell off A and buy more of B to re-balance. At least that has been my understanding.

Above two in combination means that you can cause chain reaction which is to be expected because much larger dollars is simply trying to imitate much smaller dollars. So later gets to control the former.

Index fund must balance their portfolio.

They must balance to the underlying index, not so that they hold the same value of each stock. If A goes down and B goes up they don't have to do anything unless the change is so dramatic that it causes the people who compile the index to update which stocks are in the index.

What can happen is that a stock being added/removed from a major index can cause a large amount of buying/selling by index funds as they are 'forced' to add or remove that stock in their portfolio. However that is a fairly rare occurrence.

Let's try an example. Suppose company A has 1000000 shares in total, each with market value of $100. Then its market cap is $100 million. Suppose company B has 2000000 shares total, each with market value of $150. Then its market cap is $300 million.

Index funds own shares in proportion to the market cap. So an index fund will own shares of B worth three times as much as their shares in A. Lets say we're looking at a fund that owns $6 million of B and $2 million of A.

Now suppose A's share price doubles to $200 and B's share price falls to $125. Then the value of the index funds shares will now be $2 million × ($200/$100) = $4 million of A, and $6 million × ($125/$150) = $5 million of B. Meanwhile A's market cap has changed to 1000000 × $200 = $200 million, and B's market cap has changed to 2000000 × $125 = $250 million.

Then B's market cap is 1.25 of A's market cap, so the index fund wants to be holding shares in B worth 1.25 the value of its shares in A. It currently has $4 million of A, so it wants to be holding 1.25 × $4 million = $5 million of B, which in fact is the amount that it is already holding.

I imagine the worry that "everything will be an index fund" a bit like discussing a Savannah ecology and worrying that "everything will evolve into grazing herbivores."

Clearly there are equilibrium effects here which would stop the extreme scenario you describe from arising.

As the proportion of active investors in the market falls, those that remain enjoy a greater advantage. There will therefore always be some minimum threshold of actively managed assets (due to the marginal returns from active management eventually exceeding the marginal fees).

It's an open question as to what this threshold might be, but it will certainly be orders of magnitude above what you describe.

Where would those returns for active investors come from? They're still playing a zero-sum game amongst themselves.

Seems like it's more complicated than that? Index funds do buy and sell sometimes, as some investors move money into and out of index funds. There are also dividends and stock buybacks.

It's not bad news.

There are index funds that track the S&P 500. But who would decide what a "dumb" stock is? I don't even know where to start with this concept. I would not worry about this if you are an investing noob.

You should not avoid an American-only index fund. The U.S. equity market is by far the largest in the world, so a broad index of American stocks will cover a lot of diversity. That said, there are plenty of international stock funds available as well.

I would at least look at CDs (certificates of deposit) or short term bonds, which will give you better returns than sitting in a bank account. Stocks will have a better chance for an even better return... but also a chance that the market will be down when you want to get that apartment. That's a fundamental concept for investing: higher returns come with higher risk (and vice versa).

1. No, it's just something that has happened.

2. Any level of active management would make an index fund not an index fund. You'd be going to trying to pick the best-performing stocks, which is not what an index fund tries to do (capture the overall movements of the market).

3. The general advice is to have approximately a 65/25/10 split between SP500/international/extended market funds. You can adjust as desired.

4. Stock index funds are great for long-term investments, not so much for shorter ones. You can look at bond funds as well. If you have a good amount already (>100k maybe) you can schedule a free discussion with an advisor at places like Fidelity/Vanguard/CS and have them run you through the basics.

1. Bad news for who? It's certainly an interesting development - as a higher proportion of invested assets move predictably (i.e. are passively invested), the game becomes easier for the fewer remaining active participants.

2. What is a dumb stock?

3. I don't have the answer to this but keep in mind that those with a vested interest in the success of local markets (e.g. financial advisors within a given nation) are likely to suggest that people invest more in those areas.

Your inclination to consider likely geopolitical shifts as you make these decisions is a good one.

It's probably not bad news since there are still plenty of active traders. It's just a milestone.

Nobody can predict the future and you shouldn't get your investment advice from Hacker News, but putting everything into one investment tends to be a bad idea.

> Is this a bad news?

Certainly not at half. It is an open question how high it can go before there are destabilizing effects, but it's very likely way above the 90% level.

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