What happens when everyone (or some sufficiently large portion of the population) index invests? I've heard it said that this becomes a problem, for whatever reason.
In practice, the market will become increasingly irrational, leading to an increasing arbitrage opportunity for active investors. There may be a period where active investment gives a better ROI, even when accounting for fees; but in the long term, the amount of passive investment should reach an equilibrium where the benefits active investment is equal to its overhead.
There is also the Wall Street Bets class of active investors. In the current market, I'm not convinced they are actually helping. But, in a world where no one else is activly investing, they are probably better than nothing.
That is outrageously wrong information.
Half the ownership of the US stock market is from households and mutual funds, with a third from the former.
The other half is mainly Etfs underlyings and pension funds.
Hedge funds represent less that 5% of the total US market ownership.
Most people collectively hold less than 1 or 2 percent of the stocks.
People and funds who have 100 billion invested won't be lazy.
One could say this happened anyway in the aftermath of the QE (a.k.a. money printing) response to the '08 crisis.
Where would those gains come from? It can't be that the index funds are matching the market and the active investors are doing better. Someone has to be doing worse in that situation.
One thought experiment is if being part of an index confers additional perceived value, the addition or removal from it index is an Arbitrage opportunity.
Imagine trading against someone who will reliably pay a premium for an index of "top 10 stocks". Price will spike for a stock that goes from #11 to 10, and drop for every stock that goes from 10 to 11.
Index investors will overpay for a newly listed stock and that money will go to an active investor that held it before the listing. Inversely, index investors will lose money whenever a stock is removed from the index.
Only buying indexes is different from only buying one index.
For example, someone willing to pay a $1 premium for an indexed stock.
It is trading at $5 today and becomes indexed, so you pay $6 for it. It leaves the index so you can only sell it for $5.
It doesn't matter how many times you average it, it is still a source of loss.
If you only have one index, going from position 11 to 10 increases the value of the stock. But if you have a lot of indices, all these effects should average out to basically zero, since that stock might be in thousands of indices, and a drop out from a single index will only have a marginal effect.
This is a long way of saying that a limited number of indices is an assumption of the hypothetical.
It would break the market if everyone invested in indexes because nobody is paying attention to fundamentals.
If there are a huge number of indexes and people are diligently picking between them, that is basically the same thing as being active investors.
- Concentration of ‘voting power’: if more investors flock to index funds, a smaller group of fund managers will have more voting power on behalf of their clients.
Theoretically, a ‘concentration of power’ could give [few] fund managers a lot more responsibility than they should otherwise have; that’s a lot of livelihoods to hold be responsible for.
- Increased crorrelation: if a [large enough] portion of the population invests in index funds, the returns of those funds will become more correlated with each other; a ripple could become a tsunami.
what are these livelihoods? They should be voting in the financial interest of the clients that own the index, which sounds fine to me.
Think of index fund investments as increasing gain on an amplifier — the more gain, the higher small signals can get boosted. An index fund is basically following the active investors and putting more weight behind each of their decisions. More passive investment money means a higher amplification factor.
If you go to a restaurant, point to the person next to you, and say "I'll have what they're having" then you'll get a meal of some sort. You may be happy with it, but who chose it? The person next to you. What if everyone does this? Who decides the initial meal that will propagate to all customers? One person.