What are some critiques of passive investing/index funds?

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YoungBogle
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What are some critiques of passive investing/index funds?

Post by YoungBogle » Fri Dec 28, 2018 3:57 am

What are some critiques of passive investing/or which critiques do you find most warranted?

I'll start.. when a stock's market cap increases, that means we buy more proportionally, and when a stock's market cap decreases, we buy less proportionally. One can argue you are increasingly always buying higher, and buying lower less.

Disclaimer: All of my investments are in low cost index funds (100% VTSAX). I am 100% on board with the Boglehead philosophy. The reason for this post is to better my understanding (newer investor), and to help alleviate confirmation bias. I want to open up a dialogue, I think it is important to understand your critics to improve your understand perceived weaknesses that you may not have known was there.

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Re: What are some critiques of passive investing/index funds?

Post by HEDGEFUNDIE » Fri Dec 28, 2018 4:14 am

My favorite critique of index funds is that they violate antitrust laws and will lead to the downfall of capitalism.

Companies are supposed to compete vigorously against one another. But if the shareholders of a company also owned all of its competitors, wouldn’t they implicitly prefer that the companies collude and drive prices up?

https://www.bloomberg.com/opinion/artic ... e-too-well

And if everyone ended up owning all the companies, isn’t that called communism?

https://www.bloomberg.com/opinion/artic ... capitalism

Jack Bogle himself makes a related critique about index funds’ pernicious effects on corporate governance:

https://www.google.com/amp/amp.timeinc. ... ds-problem

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Re: What are some critiques of passive investing/index funds?

Post by GoldenFinch » Fri Dec 28, 2018 5:07 am

Extensive use of index funds negatively impacts the bottom line of some individuals in the financial services industry.

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Re: What are some critiques of passive investing/index funds?

Post by boglerdude » Fri Dec 28, 2018 5:31 am

Arnott: Why Cap-Weighted Indexing Is Flawed

https://www.morningstar.com/videos/6136 ... lawed.html

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Re: What are some critiques of passive investing/index funds?

Post by JoMoney » Fri Dec 28, 2018 5:56 am

YoungBogle wrote:
Fri Dec 28, 2018 3:57 am
... when a stock's market cap increases, that means we buy more proportionally, and when a stock's market cap decreases, we buy less proportionally. One can argue you are increasingly always buying higher, and buying lower less...
When the market cap increases that doesn't necessarily mean you're buying any more of it, it just becomes a larger weight in the overall portfolio without any trading necessarily occurring at all.
If you're an accumulator, your new purchases will be proportionally weighted more to larger cap stocks at that point in time,
and when you're withdrawing, you'll be selling proportionally more of the larger cap stocks that have grown the most.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

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Re: What are some critiques of passive investing/index funds?

Post by HanSolo » Fri Dec 28, 2018 10:14 am

YoungBogle wrote:
Fri Dec 28, 2018 3:57 am
What are some critiques of passive investing/or which critiques do you find most warranted?
My critique is that the biggest and most popular index funds have a heavy concentration in Big Tech (which I've been suspecting of being grossly overvalued for several years).

Of course, I wouldn't mind Value Index (VVIAX), so my critique isn't about indexing per se, just the situation presented by the larger funds.

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Re: What are some critiques of passive investing/index funds?

Post by livesoft » Fri Dec 28, 2018 10:22 am

My favorite critiques are that they are boring and don't earn money for active sales reps.
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Re: What are some critiques of passive investing/index funds?

Post by k3vb0t » Fri Dec 28, 2018 10:28 am

The easiest critique is that you accept average market performance. You cannot outperform if you accept the average. Of course the flipside of that coin is you can't underperform either!

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Re: What are some critiques of passive investing/index funds?

Post by GoldStar » Fri Dec 28, 2018 10:31 am

The one I heard from a financial adviser is "When the market starts to tank passive index funds can't take the peddle off the gas so they continue to drive your money into the ground since it has to stay in the market; where an active manager can ease money out of the fund during a downturn mitigating your losses". I just silently chuckled to myself - never worth the energy to argue since its not my money they are trying to time the market with.

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Re: What are some critiques of passive investing/index funds?

Post by MathIsMyWayr » Fri Dec 28, 2018 10:33 am

livesoft wrote:
Fri Dec 28, 2018 10:22 am
My favorite critiques are that they are boring and don't earn money for active sales reps.
+1 Passive investing/indexing is like watching grass grow. When you stare, it does not grow. If you go away and come back later, yes, it has grown.

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Re: What are some critiques of passive investing/index funds?

Post by David Jay » Fri Dec 28, 2018 10:55 am

I think that the issue of corporate governance is an open issue. If indexing continues the current growth path, the time will come when the big mutual fund companies will be the majority stockholders in most major corporations. That may need to be addressed by the SEC.

All other arguments are - to my way of thinking - features, not bugs.
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Re: What are some critiques of passive investing/index funds?

Post by David Jay » Fri Dec 28, 2018 11:03 am

YoungBogle wrote:
Fri Dec 28, 2018 3:57 am
What are some critiques of passive investing/or which critiques do you find most warranted?

I'll start.. when a stock's market cap increases, that means we buy more proportionally, and when a stock's market cap decreases, we buy less proportionally. One can argue you are increasingly always buying higher, and buying lower less.
I find this particular critique completely unwarranted. The market is the market. Mr. Market has set the price of each and every security. I am not “buying high” or “buying low”, but simply following Mr. Market’s evaluation.

Nisiprius’ “pot of chicken stew” illustration is a great visualization.
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

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Re: What are some critiques of passive investing/index funds?

Post by kolea » Fri Dec 28, 2018 11:15 am

The critique I hear from a good friend of mine is that she outperforms the market by picking stocks. It is hard for me to argue with her since she has indeed out-performed pretty consistently for the last 15 or so years, both annually and cumulatively. Me, I am a passive index investor and happy with it but some people do seem to have a knack for picking stocks.
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Re: What are some critiques of passive investing/index funds?

Post by transient_academic » Fri Dec 28, 2018 11:39 am

The only critique I can think of that hasn't already been mentioned (or if it was I didn't see it) is the one about how if we all use index funds there won't be price discovery anymore.

The counter being that if indexes become that dominant then there will be arbitrage opportunities for savvy active investors, which would then correct the problem.

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Re: What are some critiques of passive investing/index funds?

Post by YoungBogle » Fri Dec 28, 2018 1:46 pm

David Jay wrote:
Fri Dec 28, 2018 11:03 am
YoungBogle wrote:
Fri Dec 28, 2018 3:57 am
What are some critiques of passive investing/or which critiques do you find most warranted?

I'll start.. when a stock's market cap increases, that means we buy more proportionally, and when a stock's market cap decreases, we buy less proportionally. One can argue you are increasingly always buying higher, and buying lower less.
I find this particular critique completely unwarranted. The market is the market. Mr. Market has set the price of each and every security. I am not “buying high” or “buying low”, but simply following Mr. Market’s evaluation.

Nisiprius’ “pot of chicken stew” illustration is a great visualization.
Thank you for the response, and it’s a 100% valid point you bring up.. Wasn’t the moniker “Mr. Market” created to portray the Market’s short-term irrationalities, because Mr. Market is irrational (bullish or bearish) in the short term, and more rational in the long term?

Playing devils advocate, an active manager might counter your point by saying “If you’re following Mr. Market, then you’re also following his irrational short-term bullishness, and ingoring his short-term irrational bearishness.”

I’m not saying investing based off of weighted mkt cap is bad, rather active money managers may attempt to utilize this as a critique to dissuade you and lead you to believe they are able to take advantage Mr. Market’s short term irrational behavior (which we know is near impossible).

Edited:removed duplicate “and”
Last edited by YoungBogle on Fri Dec 28, 2018 1:52 pm, edited 1 time in total.

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Re: What are some critiques of passive investing/index funds?

Post by Phineas J. Whoopee » Fri Dec 28, 2018 1:48 pm

That a person who owns only one fund, and it's a stock market index fund, will experience a loss when the market experiences one.

Of course, as advocated here, one can own fixed income assets as well, without paying somebody a couple of percent to buy them for one.

But that isn't part of the critique.

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Re: What are some critiques of passive investing/index funds?

Post by 2015 » Sat Dec 29, 2018 1:17 pm

My favorite critique is people own index funds yet find other, backdoor methods to actively invest.

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Re: What are some critiques of passive investing/index funds?

Post by JackoC » Sat Dec 29, 2018 6:33 pm

David Jay wrote:
Fri Dec 28, 2018 10:55 am
I think that the issue of corporate governance is an open issue. If indexing continues the current growth path, the time will come when the big mutual fund companies will be the majority stockholders in most major corporations. That may need to be addressed by the SEC.
I agree, that criticism deserves real consideration. Jack Bogle himself warned about it in a recent WSJ article. And it wouldn't necessarily require majority ownership to affect corporate governance at the margin, just very major ownership, which is already becoming true. Although, it's not directly relevant from the POV of an individual as investor, as opposed to citizen/voter. The concentration of ownership of stocks in the hands of a few index managers with no incentive to promote competition among companies in the same industry, since they own all of them, could result in a less efficient economy. But even if it does, that still doesn't make actively managed funds a better deal for me as an individual. It would be making the *economy* less efficient by reducing competition among companies, not making the *stock market* less efficient necessarily in pricing companies' assets, nor would it change the "Costs Matter Hypothesis" among investments. I belabor this only because, based on the thread here about the Jack Bogle article, it seems many people hear this issue as being about *stock pricing* inefficiency even after it's explained that that's not what it's about.

From an individual POV though one minor valid critique is in cases where stock indexes are constructed so as to allow front running of index changes by active traders. That actually can transfer money from index fund holders to active traders, without the active traders having to be super human geniuses. But it isn't a significant consideration for broad stock indices usually, especially not total market indexes.

There can be more significant issues though with indexing some asset classes other than stocks. Like investment grade corporate bonds. But I assume when people say 'index fund' they mainly mean 'stock broad based index fund'.

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Re: What are some critiques of passive investing/index funds?

Post by Stormbringer » Sat Dec 29, 2018 7:02 pm

YoungBogle wrote:
Fri Dec 28, 2018 3:57 am
What are some critiques of passive investing/or which critiques do you find most warranted?
I see the potential for two macro problems caused by passive investors being free-riders:
  1. If everyone indexed, the market would not have a price discovery mechanism because everyone is a price-taker. It isn't at all clear at what point that starts to become a problem.
  2. Good corporate governance requires shareholder participation and oversight, which isn't compatible with ultra-low cost index funds. As more and more shares are held passively, management gets stronger and stronger, potentially at the shareholder's expense.
"Compound interest is the most powerful force in the universe." - Albert Einstein

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Re: What are some critiques of passive investing/index funds?

Post by HEDGEFUNDIE » Sat Dec 29, 2018 7:50 pm

JackoC wrote:
Sat Dec 29, 2018 6:33 pm
The concentration of ownership of stocks in the hands of a few index managers with no incentive to promote competition among companies in the same industry, since they own all of them, could result in a less efficient economy. But even if it does, that still doesn't make actively managed funds a better deal for me as an individual. It would be making the *economy* less efficient by reducing competition among companies, not making the *stock market* less efficient necessarily in pricing companies' assets, nor would it change the "Costs Matter Hypothesis" among investments.
A less efficient economy should worry you a lot more than active manager fees. The latter can be avoided, unlike the former.

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Re: What are some critiques of passive investing/index funds?

Post by JackoC » Sat Dec 29, 2018 9:31 pm

HEDGEFUNDIE wrote:
Sat Dec 29, 2018 7:50 pm
JackoC wrote:
Sat Dec 29, 2018 6:33 pm
The concentration of ownership of stocks in the hands of a few index managers with no incentive to promote competition among companies in the same industry, since they own all of them, could result in a less efficient economy. But even if it does, that still doesn't make actively managed funds a better deal for me as an individual. It would be making the *economy* less efficient by reducing competition among companies, not making the *stock market* less efficient necessarily in pricing companies' assets, nor would it change the "Costs Matter Hypothesis" among investments.
A less efficient economy should worry you a lot more than active manager fees. The latter can be avoided, unlike the former.
My point wasn't about which is more worrisome, but that there's nothing as *individual investor* I can do about a concentration of ownership causing a less efficient economy. The problem, while potentially important IMO, is arguably off topic for this forum since the solutions would be changes to public policy, which is generally not allowed to be debated here. I assume the previous long thread about it (though mostly posts by people who obviously hadn't read the article) was tolerated because based on an article by Jack Bogle.

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Re: What are some critiques of passive investing/index funds?

Post by arcticpineapplecorp. » Sat Dec 29, 2018 9:59 pm

"Index Funds are Unamerican!" (compliements of the Leuthold Group circa 1976 advertising campaign featuring Uncle Sam):

https://www.google.com/search?q=index+f ... iKYJOZGjlM:

"Help Stamp Out Index Funds"

And this (complements of Bogle Financial Markets Research Center https://www.vanguard.com/bogle_site/sp20040413.html):
Fidelity Chairman Edward C. Johnson led the skeptics, assuring the world that Fidelity had no intention of following Vanguard's lead: "I can't believe that the great mass of investors are going to be satisfied with just receiving average returns. The name of the game is to be the best.
That was then, this is now:
Fidelity has been managing index funds for more than 25 years. The company, which is the 2nd largest index mutual fund manager in the industry with more than $216 billion in assets under management,1 now offers 19 Fidelity equity, fixed income and hybrid index mutual funds, 13 Fidelity Freedom® Index Funds, and 12 Fidelity passive ETFs.
https://www.fidelity.com/about-fidelity ... nd-line-up
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Re: What are some critiques of passive investing/index funds?

Post by pastel » Sat Dec 29, 2018 10:28 pm

Some posters above mentioned Bogle's WSJ article, it is here: https://www.wsj.com/articles/bogle-soun ... 1543504551

In a similar vain, The Atlantic also published an article on how indexing diminishes competition: https://www.theatlantic.com/magazine/ar ... il/534183/

Here's my own take. One critical assumption we all have is that the market, in the long run, will go up. Many of us hold a significant part of our savings in a US total market index (eg VTSAX), but as we have seen, the market of a single country does not always rise. Even if we add international or use a global fund, we are still assuming that equity markets will rise. Will this be the case in the next 100 years? Probably, but we can't be sure. Also, a growing number of firms are staying out of public equity markets (Uber, Airbnb, Bytedance), so the index fund can't capture that growth.

And as we've seen this past week, more index funds may cause more volatility at the end of the trading day. If a significant number of people buy or sell on a given day, the fund has to cover this. By 4pm, their job is to match the index, and their large trading volumes may cause upward or downward spikes. As a long term investor this shouldn't be too worrying, but it still feels chaotic.

As for the idea that price discovery will be lost - I have never been a strong believer in efficient markets anyway. If the entire market gets inflated, there will always be people out there to short. Indeed, there are a variety of ETFs that short the market or a given index.

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Re: What are some critiques of passive investing/index funds?

Post by make_a_better_world » Sun Dec 30, 2018 12:35 am

I see two significant potential downsides, which are both related to a scenario where index funds have been widely adopted by retail investors and institutions alike, and comprise a majority stake of all stocks in the market:

1. Indexed, passive investment fund managers do not evaluate individual companies. If indices comprise the majority of a company's stock, then poor performance at the company-level may no longer be tightly correlated with stock price as the index fund will continue to purchase and hold shares regardless. This may result in star-companies not taking off and poorly performing companies being artificially propped up. The variation in the valuation of individual companies is dependent on investors trying to pick winners and losers after carefully analyzing available data and formulating expectations.

2. Index fund managers may find themselves the majority stake holders of several individual companies, meaning a small group of fund managers will theoretically wield an immense amount of power over the direction of these companies under the assumption that current regulations do not change.

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Re: What are some critiques of passive investing/index funds?

Post by sf_tech_saver » Sun Dec 30, 2018 3:15 am

My biggest critique is that while its a great bet on average (best?) the overall upside is somewhat limited to the growth of the whole market. Said another way, I think index funds are a great way to invest once you are already 'rich' but a fairly lousy way of becoming so.

I couldn't be happier to have diversified away from a risky startup/IPO into VTI/VTEB -- but I only ever really experienced a seven figure(s) outcome by going extremely long/deep on a career bet on my companies single stock.

I've been obsessed with Bogleheads over the last few months as I've worked to organize my investments (house purchase, bonds, stocks, cash) and keep my life predictable, affordable and boring. That said I'm doing so such that I can free time back up in 2019 to figure out the next 'go deep' bets to make on a company/equity and it might also include angel investing in tech companies where I feel I can be an impactful advisor.

Bogleheads approach is proven and airtight philosophy for general market investing but this is only a foundation for me to make more speculative investments of my career/time and a limited amount of assets.

Said another way -- zero of the world's top 50 fortunes were built on Boglehead investing style.
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Re: What are some critiques of passive investing/index funds?

Post by Call_Me_Op » Sun Dec 30, 2018 7:39 am

YoungBogle wrote:
Fri Dec 28, 2018 3:57 am
What are some critiques of passive investing/or which critiques do you find most warranted?
None I have seen are warranted in terms of effects on the individual investor. You must always consider the source.
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Re: What are some critiques of passive investing/index funds?

Post by samsdad » Sun Dec 30, 2018 7:40 am

sf_tech_saver wrote:
Sun Dec 30, 2018 3:15 am
My biggest critique is that while its a great bet on average (best?) the overall upside is somewhat limited to the growth of the whole market. Said another way, I think index funds are a great way to invest once you are already 'rich' but a fairly lousy way of becoming so.

I couldn't be happier to have diversified away from a risky startup/IPO into VTI/VTEB -- but I only ever really experienced a seven figure(s) outcome by going extremely long/deep on a career bet on my companies single stock.

I've been obsessed with Bogleheads over the last few months as I've worked to organize my investments (house purchase, bonds, stocks, cash) and keep my life predictable, affordable and boring. That said I'm doing so such that I can free time back up in 2019 to figure out the next 'go deep' bets to make on a company/equity and it might also include angel investing in tech companies where I feel I can be an impactful advisor.

Bogleheads approach is proven and airtight philosophy for general market investing but this is only a foundation for me to make more speculative investments of my career/time and a limited amount of assets.

Said another way -- zero of the world's top 50 fortunes were built on Boglehead investing style.
Someone once said that the point of investing was not to get rich—but not to die poor.

“Speculative investments” is an oxymoron to some, by the way.

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Re: What are some critiques of passive investing/index funds?

Post by HEDGEFUNDIE » Sun Dec 30, 2018 8:13 am

sf_tech_saver wrote:
Sun Dec 30, 2018 3:15 am
I couldn't be happier to have diversified away from a risky startup/IPO into VTI/VTEB -- but I only ever really experienced a seven figure(s) outcome by going extremely long/deep on a career bet on my companies single stock.
Interesting perspective. Working in the Bay Area I’ve actually come to the opposite conclusion.

Let’s say you were offered an early employee role at a startup with a significant equity component. Let’s say the equity represents an opportunity cost of $50k/year that you would otherwise receive in cash salary at a MegaCorp. Which is the better financial play (setting aside the other aspects of entrepreneurial life), taking the startup job and waiting for a liquidity event, or taking the MegaCorp job and investing the $50k/yr in the stock market?

Over the last 30 years the S&P 500 has returned 11% CAGR. Investing $50k each year with that rate of compounding would yield $1M by the end of year 10. Yes, this is an obviously rosy scenario for any 10 year period, but I would argue it is still more likely to occur than successfully picking the right early stage startup that would produce a similar exit.

I was actually faced with this exact situation when I moved to the Bay Area last year. I took the stable job and have been heavily aggressive in my portfolio since then. We’ll see if it works out.

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Re: What are some critiques of passive investing/index funds?

Post by JackoC » Sun Dec 30, 2018 9:51 am

make_a_better_world wrote:
Sun Dec 30, 2018 12:35 am
I see two significant potential downsides, which are both related to a scenario where index funds have been widely adopted by retail investors and institutions alike, and comprise a majority stake of all stocks in the market:

1. Indexed, passive investment fund managers do not evaluate individual companies. If indices comprise the majority of a company's stock, then poor performance at the company-level may no longer be tightly correlated with stock price as the index fund will continue to purchase and hold shares regardless. This may result in star-companies not taking off and poorly performing companies being artificially propped up. The variation in the valuation of individual companies is dependent on investors trying to pick winners and losers after carefully analyzing available data and formulating expectations.

2. Index fund managers may find themselves the majority stake holders of several individual companies, meaning a small group of fund managers will theoretically wield an immense amount of power over the direction of these companies under the assumption that current regulations do not change.
This is a good post in clearly separating the two issues which are often confused

1. This is not plausibly going to become a problem IMO. If stocks are mispriced relative to the fundamentals of companies, there will always be independent money analyzing individual stocks and going long and short ones which get out of line. The market can't be efficient unless there are people making money arbitraging out inefficiencies. The mainly correct POV of BH'ism is that retail investors by and large cannot get in on that money making without paying fees that cancel out (or more than) their gains. But the further extension that *nobody* makes money arbitraging out market inefficiencies is wrong. Money is and will continue to be profitably invested in arbing out pricing inefficiencies as long as law and regulation don't prevent it. Index fund dominance is not a direct threat to *stock market* efficiency.

2. In contrast, index fund dominance could be a threat to *real economy* efficiency. This is because index fund managers, and their shareholders, have no vested interest in bare knuckle competition between the major public stock firms in an index, all of which they own. This drag on competition doesn't need 'everyone' to index. It just needs the index funds to have an effective controlling interest, which is usually not anywhere near 100%. There might be some negative effect from stock index funds on competition even now.

To oversimplify but illustrate, if one big private equity fund or famous individual investor (say Carl Icahn, I won't say Buffett because some people hear that name and assume whatever is associated with it must be all sweetness and light :happy ) bought a controlling interest in all the major companies in an industry, everyone would immediately recognize why that was a problem. It would not be that it caused the remaining public shares of the various companies to be mispriced relative to one another. It would be what it meant for the competitive policy of those companies now that their CEO's and boards all effectively reported to the same controlling owner.

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Re: What are some critiques of passive investing/index funds?

Post by SpringMan » Sun Dec 30, 2018 10:05 am

School gunning survivor, David Hogg, was critical of Vanguard and called for a boycott of Vanguard because their index funds hold firearms companies. I don't agree. Even Vanguard's FTSE Social Index fund has big monster mega-banks that in my opinion are more evil than firearms companies.
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Re: What are some critiques of passive investing/index funds?

Post by Revision17 » Sun Dec 30, 2018 10:45 am

SpringMan wrote:
Sun Dec 30, 2018 10:05 am
School gunning survivor, David Hogg, was critical of Vanguard and called for a boycott of Vanguard because their index funds hold firearms companies. I don't agree. Even Vanguard's FTSE Social Index fund has big monster mega-banks that in my opinion are more evil than firearms companies.
Interestingly, I had a look at ESGV, which states:
Specifically excludes stocks of companies in the following industries: adult entertainment, alcohol and tobacco, weapons, fossil fuels, gambling, and nuclear power.
I feel like nuclear power has been demonized, and deserves a place in the clean power portfolio of the next century. So I decided to keep rolling with total stock market.

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Re: What are some critiques of passive investing/index funds?

Post by sf_tech_saver » Sun Dec 30, 2018 3:13 pm

HEDGEFUNDIE wrote:
Sun Dec 30, 2018 8:13 am
sf_tech_saver wrote:
Sun Dec 30, 2018 3:15 am
I couldn't be happier to have diversified away from a risky startup/IPO into VTI/VTEB -- but I only ever really experienced a seven figure(s) outcome by going extremely long/deep on a career bet on my companies single stock.
Interesting perspective. Working in the Bay Area I’ve actually come to the opposite conclusion.

Let’s say you were offered an early employee role at a startup with a significant equity component. Let’s say the equity represents an opportunity cost of $50k/year that you would otherwise receive in cash salary at a MegaCorp. Which is the better financial play (setting aside the other aspects of entrepreneurial life), taking the startup job and waiting for a liquidity event, or taking the MegaCorp job and investing the $50k/yr in the stock market?

Over the last 30 years the S&P 500 has returned 11% CAGR. Investing $50k each year with that rate of compounding would yield $1M by the end of year 10. Yes, this is an obviously rosy scenario for any 10 year period, but I would argue it is still more likely to occur than successfully picking the right early stage startup that would produce a similar exit.

I was actually faced with this exact situation when I moved to the Bay Area last year. I took the stable job and have been heavily aggressive in my portfolio since then. We’ll see if it works out.
Yes, if you assume you have a fixed title role at startup vs. big corp your math holds up very well. Its why Google/FB/Netflix/etc dominate hiring and set the prices for talent far more than startups who right now are fighting on the margins to attract talent.

What I found though is that if you compound the job level growth potential, from say manager to CXO while at a smaller company then its hard to beat new opportunities. If you look at who runs Google for instance most of them have been there a long long time which means if you join them today the chances of you rising up to CXO level there are slim.

I LOVE Boggle heads forum and believe the advice here is better than almost ALL 'professional' extractive investment vehicles and advisors. I wish I'd discovered it far earlier in my life as I used to park a few hundred K in a Wells Fargo savings account and all of my retirement was purely 401k. :oops: At the same time I was obsessed with certain areas of the technology market that allowed me to grow to a modest but sustainable $3.8M net worth now in the Bay Area at 40. This despite not owning real-estate there until last week....

To posters in their 20's and 30's congrats on discovering this forum early (I was 40! :shock: ) but don't forget to invest like crazy in yourselves and learning about game changing new ideas.....
VTI is a modern marvel

sf_tech_saver
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Re: What are some critiques of passive investing/index funds?

Post by sf_tech_saver » Sun Dec 30, 2018 3:16 pm

samsdad wrote:
Sun Dec 30, 2018 7:40 am
sf_tech_saver wrote:
Sun Dec 30, 2018 3:15 am
My biggest critique is that while its a great bet on average (best?) the overall upside is somewhat limited to the growth of the whole market. Said another way, I think index funds are a great way to invest once you are already 'rich' but a fairly lousy way of becoming so.

I couldn't be happier to have diversified away from a risky startup/IPO into VTI/VTEB -- but I only ever really experienced a seven figure(s) outcome by going extremely long/deep on a career bet on my companies single stock.

I've been obsessed with Bogleheads over the last few months as I've worked to organize my investments (house purchase, bonds, stocks, cash) and keep my life predictable, affordable and boring. That said I'm doing so such that I can free time back up in 2019 to figure out the next 'go deep' bets to make on a company/equity and it might also include angel investing in tech companies where I feel I can be an impactful advisor.

Bogleheads approach is proven and airtight philosophy for general market investing but this is only a foundation for me to make more speculative investments of my career/time and a limited amount of assets.

Said another way -- zero of the world's top 50 fortunes were built on Boglehead investing style.
Someone once said that the point of investing was not to get rich—but not to die poor.

“Speculative investments” is an oxymoron to some, by the way.
"Someone once said that the point of investing was not to get rich—but not to die poor." <--this is a GREAT forum for this...nails the use case for this knowledge IMHO.

Thanks for cleaning up my language on speculative investments..... #newbie
VTI is a modern marvel

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Re: What are some critiques of passive investing/index funds?

Post by HEDGEFUNDIE » Sun Dec 30, 2018 3:32 pm

sf_tech_saver wrote:
Sun Dec 30, 2018 3:13 pm
To posters in their 20's and 30's congrats on discovering this forum early (I was 40! :shock: ) but don't forget to invest like crazy in yourselves and learning about game changing new ideas.....
Agree 100%. Taking too little risk in one’s career is a common mistake I see on this forum and in real life. I recently started a post on staying career-relevant in one’s 50s and much of the advice included staying curious and current.

As for me, I’m doubling down on the API economy. Let’s hope it has legs!

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Re: What are some critiques of passive investing/index funds?

Post by samsdad » Sun Dec 30, 2018 4:55 pm

HEDGEFUNDIE wrote:
Sun Dec 30, 2018 3:32 pm
sf_tech_saver wrote:
Sun Dec 30, 2018 3:13 pm
To posters in their 20's and 30's congrats on discovering this forum early (I was 40! :shock: ) but don't forget to invest like crazy in yourselves and learning about game changing new ideas.....
Agree 100%. Taking too little risk in one’s career is a common mistake I see on this forum and in real life. I recently started a post on staying career-relevant in one’s 50s and much of the advice included staying curious and current.

As for me, I’m doubling down on the API economy. Let’s hope it has legs!
Agreed. Too little risk early on. I also agree with you on that other thread re: not reassuring.

That makes two things that I agree with you on, just for the record.

What is the API economy?

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Rick Ferri
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Re: What are some critiques of passive investing/index funds?

Post by Rick Ferri » Sun Dec 30, 2018 5:13 pm

YoungBogle wrote:
Fri Dec 28, 2018 3:57 am
Disclaimer: All of my investments are in low cost index funds (100% VTSAX). I am 100% on board with the Boglehead philosophy. The reason for this post is to better my understanding (newer investor), and to help alleviate confirmation bias. I want to open up a dialogue, I think it is important to understand your critics to improve your understand perceived weaknesses that you may not have known was there.
Congratulations on seeing the benefits of low-cost index investing. I wish it were easy to skip the skepticism that all new index investors have and go right to full-tilt belief. But that's not how it happens.

Change takes a choppy course that’s well documented in psychotherapy. Change occurs in stages, processes and levels. There is determination and action, relapse, restart, progress, setback, and repeat until the change is finally ingrained in our subconscious. This is what happens to us after moving out of darkness into index enlightenment.

We’re determined to take positive steps toward changing our portfolios and we have a deep desire to get it done right. However, actions are always preceded by more research and analysis to find the best strategy for our needs. The worst thing is to make more mistakes because we’ve already wasted too much time and money. Ironically, trying to make investing easier often makes it more complicated.

Complexity is created when we become perplexed over the choices available. There are many ways an enlightened investor can get caught up in complexity. Most of the problems stem from trying to develop a perfect portfolio; the optimal asset allocation, best security selection and ideal account maintenance process. This search for optimal leads in many directions and fragments again with every new article or book we read. This can lead to uncertainty, indecision, and unnecessary fiddling.

“The enemy of a good plan is the dream of a perfect plan,” said Prussian General Karl von Clausewitz. Some complexity is required when there are unique situations, but when complexity shines for the sake of finding perfection it becomes a black hole that sucks in everything around it.

When you reach the fourth and final stage in your index investor education, questions like the ones you're posing will disappear. You’ll stop tinkering with your portfolio in a never-ending search for the optimal strategy and shift your focus to a few big things that matter. Those in stage-4 do the equivalent of downsizing. They reduce the number of investments to a handful of long-term holdings, consolidate accounts at one custodian if feasible, and implement automated maintenance so they don’t have to look at your portfolio as often.

In the fourth and final stage, portfolio management is about “simplicity and economy” as John Bogle elegantly put it. You own fewer funds in fewer accounts if feasible, so less can go wrong. You won’t to check your portfolio regularly, sometimes not for months or even longer. Account maintenance takes less than an hour because there’s not going to be an asset allocation change or a change to the investment selection, unless perhaps something major has changed in your life.

I realize you're not there yet and you have a ways to go. Keep at it. It's worth your time.

Rick Ferri
The Education of an Index Investor: born in darkness, finds indexing enlightenment, overcomplicates everything, embraces simplicity.

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Re: What are some critiques of passive investing/index funds?

Post by HEDGEFUNDIE » Sun Dec 30, 2018 5:15 pm

samsdad wrote:
Sun Dec 30, 2018 4:55 pm
Agreed. Too little risk early on. I also agree with you on that other thread re: not reassuring.

That makes two things that I agree with you on, just for the record.
:sharebeer
What is the API economy?
APIs are a type of software that enable developers to connect to some functionality that they would otherwise either (1) need to build themselves, or (2) purchase as part of a larger package they don’t need and can’t customize.

For example if I wanted to include a mapping feature on my website or app, instead of taking months to build my own maps, I could just connect to the Google Maps API with a few lines of code, and all of a sudden I would have Google Maps working on my website / app. A good API is flexible enough to (1) meet the specific needs of my users and (2) play well with the other features of my website / app.

The “economy” part of the term refers to companies opening up and monetizing access to their APIs. It’s akin to a new generation of software business model, post on-prem, post SaaS.
Last edited by HEDGEFUNDIE on Sun Dec 30, 2018 5:29 pm, edited 1 time in total.

samsdad
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Re: What are some critiques of passive investing/index funds?

Post by samsdad » Sun Dec 30, 2018 5:26 pm

Funny didn’t know that’s what you were referring to. I did exactly that on my business website re google maps.

Pu239
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Re: What are some critiques of passive investing/index funds?

Post by Pu239 » Sun Dec 30, 2018 7:27 pm

k3vb0t wrote:
Fri Dec 28, 2018 10:28 am
The easiest critique is that you accept average market performance. You cannot outperform if you accept the average. Of course the flipside of that coin is you can't underperform either!
At least index fund performance is a type of guarantee (not that much worse or better than the index). Try asking for a performance guarantee from an active manager.

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Re: What are some critiques of passive investing/index funds?

Post by TVD » Sun Dec 30, 2018 9:47 pm

Steven Bregman is probably one of the better resources to critique indexation.
Grants Conf presentation
https://vimeo.com/209940152/f2154e4d3d
https://www.grantspub.com/files/present ... nal[2].pdf

Bregman vs. Bogle (not really pro/con indexation directly but at least informative)
https://vimeo.com/211337445/ecd20e6a57

My critiques (some taken from Bregman)
1. Risks of liquidity mismatch (more risk with bond etf than equity etf but if a sell off happens, can be a major problem. I also think it will be a problem not just in etf but maybe in mututal fund indexation).
--Given much greater turnover of index funds compared to underlying securities, liquidity mismatch may be at even greater unperceived risk.
--Given vast greater number of indexes compared to number of securities available (something like 3M indexes to 45K listed securities), again possibility of liquidity mismatch may be a greater risk than indicated.
--May mask lack of market liquidity up to a certain point.
2. Risks of unintended correlations.
--Cap weighted indexes may be heavily weighted towards a set of securities.
---Different indexes incorporate select securities with greater liquidity making relatively different indexes sharing the some of the same securities. If a sell off in one sector occurs, it may act as a contagion for other indexes.
--Fewer places to hide in a selloff.
3. Lack of price discovery. i.e. automatic bid
--Fewer shareholder activists/governance to keep management in check e.g. share buybacks.
--Indexation may increase equity financing of "zombie" companies.
--Potentially may threaten the proper allocation of capital (i.e. capitalism)
--Lead to overvaluation of current market.
4. Assumption that equities (and bonds) will "always" increase in price/returns during one's investing lifespan.
5. Lack of a "stop loss". Lack of a point where someone says their assumptions were wrong. Until, a major selloff occurs and then people start rationalizing a stop loss as their maximum tolerated loss.
6. Lack of substantial cash allocation.
--Not able to take advantage of advantageous opportunities when they arise.
7. It has become a major investment approach.
--Estimated at 30-50% of market.
--Defeats purpose of indexation where benefit is to ride on the coat tails of smarter market participants and is now its own market fundamental.
--Will increase risks of rapid selloffs.
8. Questionable long term returns.
--Move to float weighted market cap in S&P back in ~2005 may have demonstrated better historical returns than actually maintaining market cap weightings.
9. Holders of indexes dont really know what they own in terms of underlying secruities.

That being said, I believe in indexes, especially when the cycle turns and we go back to times when indexation approaches are held in contempt like back in the 1970s-80s.

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Re: What are some critiques of passive investing/index funds?

Post by vineviz » Sun Dec 30, 2018 10:14 pm

make_a_better_world wrote:
Sun Dec 30, 2018 12:35 am
2. Index fund managers may find themselves the majority stake holders of several individual companies, meaning a small group of fund managers will theoretically wield an immense amount of power over the direction of these companies under the assumption that current regulations do not change.
This isn't really a critique of either passive investing or index funds, since mutual fund companies running actively managed funds would be (and have been) in exactly the same position.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: What are some critiques of passive investing/index funds?

Post by MiddleOfTheRoad » Mon Dec 31, 2018 1:55 am

sf_tech_saver wrote:
Sun Dec 30, 2018 3:15 am
My biggest critique is that while its a great bet on average (best?) the overall upside is somewhat limited to the growth of the whole market. Said another way, I think index funds are a great way to invest once you are already 'rich' but a fairly lousy way of becoming so.

I couldn't be happier to have diversified away from a risky startup/IPO into VTI/VTEB -- but I only ever really experienced a seven figure(s) outcome by going extremely long/deep on a career bet on my companies single stock.

I've been obsessed with Bogleheads over the last few months as I've worked to organize my investments (house purchase, bonds, stocks, cash) and keep my life predictable, affordable and boring. That said I'm doing so such that I can free time back up in 2019 to figure out the next 'go deep' bets to make on a company/equity and it might also include angel investing in tech companies where I feel I can be an impactful advisor.

Bogleheads approach is proven and airtight philosophy for general market investing but this is only a foundation for me to make more speculative investments of my career/time and a limited amount of assets.

Said another way -- zero of the world's top 50 fortunes were built on Boglehead investing style.
It is funny that people always think that “Boglehead approach” is ultra conservative and apply to all aspect of the life of a Boglehead. Please read the wiki again.

You index with your investments so you can afford to take risks with your career/other part of your life. As in FI allow you to do what you want. Another level of diversification.

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Re: What are some critiques of passive investing/index funds?

Post by HEDGEFUNDIE » Mon Dec 31, 2018 2:03 am

vineviz wrote:
Sun Dec 30, 2018 10:14 pm
make_a_better_world wrote:
Sun Dec 30, 2018 12:35 am
2. Index fund managers may find themselves the majority stake holders of several individual companies, meaning a small group of fund managers will theoretically wield an immense amount of power over the direction of these companies under the assumption that current regulations do not change.
This isn't really a critique of either passive investing or index funds, since mutual fund companies running actively managed funds would be (and have been) in exactly the same position.
Which is why the real critique is the one that takes us into socialism, when everyone owns all the companies via index funds.

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Re: What are some critiques of passive investing/index funds?

Post by JackoC » Mon Dec 31, 2018 11:27 am

vineviz wrote:
Sun Dec 30, 2018 10:14 pm
make_a_better_world wrote:
Sun Dec 30, 2018 12:35 am
2. Index fund managers may find themselves the majority stake holders of several individual companies, meaning a small group of fund managers will theoretically wield an immense amount of power over the direction of these companies under the assumption that current regulations do not change.
This isn't really a critique of either passive investing or index funds, since mutual fund companies running actively managed funds would be (and have been) in exactly the same position.
The problem though isn't that a fund is controlling owner of 'several', but where it owns all of the companies in an industry so has reduced interest in those companies competing vigorously against one another. An active fund theoretically could end up in that position and Vanguard, BlackRock, Fidelity etc which are headed toward being controlling owners of lots of companies, run some active funds. But if there weren't any index funds (not proposing that, just saying 'if') you could regulate that problem pretty easily by saying a given active fund manager or fund company couldn't have near-controlling holdings in all the companies in a given industry, again just like a single private equity fund wouldn't be able to do buy outs of every company in an industry. The active managers would have to pick and choose which companies/stocks in an industry they like (thus retaining an incentive as owners to promote no holds barred competition for their company to beat the other ones). And active managers usually do that anyway, they like Delta stock but they don't like United stock etc, you can see them nattering about that all day on CNBC. Sometimes it's 'I like all the airlines right now', but if you prohibited a fund from actually owning all the airline stocks it wouldn't affect the basic function of active funds very much, they'd just decide which one they like a little more. But if you imposed that kind of regulation on index funds it *would* undermine their basic function. That's the dilemma, and why it's an index fund problem.

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Critiques vs. Reality

Post by Taylor Larimore » Mon Dec 31, 2018 12:05 pm

YoungBogle wrote:
Fri Dec 28, 2018 3:57 am

All of my investments are in low cost index funds (100% VTSAX). I am 100% on board with the Boglehead philosophy. The reason for this post is to better my understanding (newer investor), and to help alleviate confirmation bias. I want to open up a dialogue, I think it is important to understand your critics to improve your understand perceived weaknesses that you may not have known was there.
YoungBogle:

Despite the critics, this is The Bottom Line:
Over the 15-year investment horizon, 92.43% of large-cap
managers, 95.13% of mid-cap managers, and 97.70% of small-cap
managers failed to outperform (their benchmark index) on a relative basis.
https://us.spindices.com/documents/spiv ... r-2018.pdf

Stay the Course and Happy New Year!

Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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vineviz
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Re: What are some critiques of passive investing/index funds?

Post by vineviz » Mon Dec 31, 2018 12:24 pm

JackoC wrote:
Mon Dec 31, 2018 11:27 am
The problem though isn't that a fund is controlling owner of 'several', but where it owns all of the companies in an industry so has reduced interest in those companies competing vigorously against one another. An active fund theoretically could end up in that position and Vanguard, BlackRock, Fidelity etc which are headed toward being controlling owners of lots of companies, run some active funds.
Again, there's nothing here that makes this a special problem for managers of index funds.

Look at the holdings of the biggest active fund companies: how many companies in the S&P 500 are NOT owned by Fidelity, Capital Research and Management, Invesco, MFS, Putnam, Federated, Janus Henderson, Wellington, Goldman Sachs, etc.?
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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Re: What are some critiques of passive investing/index funds?

Post by heyyou » Mon Dec 31, 2018 12:42 pm

Winston Churchill, “Democracy is the worst form of government, except for all the others.”
The same could be said about passive investing. Accepting average returns for decades is not the lesson from highly publicized sporting events. The results of passive investing are too slow to be attractive to the young investors, which is the ideal time for them to adopt passive investing. It is too staid, there is no sparkle, no flashy results, just a bunch of geezers saying "You should do this...."

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Re: What are some critiques of passive investing/index funds?

Post by paper200 » Mon Dec 31, 2018 5:01 pm

Firstly, index investing has been sealing leaks in the money pipeline from average investors to the middlemen - that is why the critique.
Secondly, even when "fund/hedge fund managers" and individual investors were owning company stocks as a larger percent share holders of companies (circa 1980's/90's) they were not more effective in a company's direction or effectiveness. Companies failed or succeeded mainly on their "moat" (Buffet) and managing of the "moat". For an average investor, indexing is a boon, to participate in the market and cutting out the middleman. Look, middlemen have been cut out in a lot of other businesses/activities with advent of computers/software. It used to cost me $25-50 for a trade in the late '80s and early 90's plus the associated loss of buy high/sell low :annoyed

Indexing and associated asset allocation is the way to go for an average investor focused on their life other than finance.
Having freedom, food and roof is being 90% lucky in life and so is index investing. So, don't let the remaining 10% bother you.

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Re: What are some critiques of passive investing/index funds?

Post by HEDGEFUNDIE » Mon Dec 31, 2018 5:12 pm

paper200 wrote:
Mon Dec 31, 2018 5:01 pm
Indexing and associated asset allocation is the way to go for an average investor focused on their life other than finance.
Classic “tragedy of the commons”. What is good for the individual is leading to common, passive ownership in the aggregate. Which will lead to complacent management, reduced competition, and drive down economic growth and investment returns for everyone.

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Re: What are some critiques of passive investing/index funds?

Post by Pu239 » Mon Dec 31, 2018 11:02 pm

HEDGEFUNDIE wrote:
Mon Dec 31, 2018 2:03 am
Which is why the real critique is the one that takes us into socialism, when everyone owns all the companies via index funds.
I can see your point if all people, taxpayers, or even all employees of companies who make up the market were to own the entire stock market roughly equally in index funds, but investors??? For example, if 99% of investors own 40% of the index and 1% owns 60%, is that socialism? Index funds succeed because they offer superior performance over alternatives. Free market at work.

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