Comment by throw0101a | Hacker News Reader

Comment by throw0101a | Hacker News Reader

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> When most people talk about investing in index funds they're largely talking about funds like eg. $SPY, not total market funds like $VTI.

You're not wrong, but for most people, most of the time, this quibble is not worth getting into.

Too many people are not saving anything, either because they (feel they) don't have enough income, are too scared of headlines, or just are not financially literate enough. If these people manage to get something (anything) going, even if it is into a 'non-optimal' S&P 500 fund, that's getting them from 0 to 80. I would be happy with more people doing 'only' that.

If you want to try to try to get them from 80 to 100, be my guest: but IMHO the perfect is the enemy of the good in this case.

> The usual counterargument to this is that we should reach an equilibrium where active managers will then be free to invest in companies that are undervalued simply because they're not a part of an index, but of course that also is making a number of assumptions.

There will always people who think they can do better, and some of those people will be right (at least some of the time):

* https://en.wikipedia.org/wiki/Grossman-Stiglitz_Paradox

The concern isn't that it's bad on the individual level, but that it might represent a long-term structural problem when everyone's doing it. If we end up in a scenario where the prices of S&P 500 stocks are determined primarily by the number of indexed investors rather than the performance of the underlying companies... well, that's a Ponzi structure, where the performance of index funds depends critically on people continuing to invest in them.

Although it appears (https://www.economist.com/business/2020/08/06/joining-the-s-...) that we aren't actually heading towards that scenario right now, I think it's a possibility worth some concern.

> If we end up in a scenario where the prices of S&P 500 stocks are determined primarily by the number of indexed investors rather than the performance of the underlying companies...

The prices of individual equities is determined by buyers and sellers coming to an agreement, not buy-and-holders. As long as there are two people who think they can take advantage of each other, there will be price discovery:

* https://en.wikipedia.org/wiki/Grossman-Stiglitz_Paradox

Ben Felix, of PWL Capital in Canada, has good article/video on this:

* https://www.pwlcapital.com/there-is-no-such-thing-as-an-inde...

* https://rationalreminder.ca/blog/2020/1/31/there-is-no-such-...

From the article(s), Blackrock estimated that only about 5% of buy and selling is done by index funds, so the vast majority of market activity, where price discovery happens, is still with the active folks.

See also the recent financial markets discussion with some of the sub-threads on about the (alleged?) usefulness of HFT systems in keeping liquidity high:

* https://news.ycombinator.com/item?id=24746836

> You're not wrong, but for most people, most of the time, this quibble is not worth getting into.

Sure. I assumed we were talking about whether passive investing could potentially cause negative effects at scale, not whether your average person should invest or not. I don't think the latter is much of a discussion (i.e. yes, they should).

When people criticize passive investing, they're largely criticizing increased institutional passive investment, not retail investors--retail investors don't generally affect the market much one way or the other. And yes, even many institutional funds invest in indices that aren't just total market indices.

If the concern about said passive investing is valid, this of course may end up affecting many average americans down the line, eg. CalSTRS is one of the largest funds in the world.

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