Passive Fund Doomsday

I ran across an interesting article this week. Yahoo Finance conducted an interview with the indexing legend himself, Jack Bogle, and he made an interesting comment concerning index investing. He stated the only word to describe everyone indexing is chaos, catastrophe. So what is the issue and why would Jack Bogle of all people make such a statement?

In my opinion it has everything to do with incorrect valuations. If the entire world indexed stocks, said stocks would all be valued the same. Stocks shouldn’t have the same value because some are worth more than others. Great companies would be undervalued and struggling companies would be overvalued. Just my two cents but as indexing becomes more and more popular, active funds might just become more successful.

Indexing would naturally creates more extremes in valuations. Just a theory of mine but it would seem that picking winners would be slightly easier for fund managers. The value stocks should be easier to spot. All of my hypothesizing is most likely in vain because even Jack himself believes that the chance of every fund becoming index based is zero.

There will always be those who believe they can beat the market. Even if the statistics say that you can’t, there will always be those who believe they can. Even more than that, there always be consumers who will pay a premium for the shot at better returns. It is human nature to reject the notion of being average. Not everyone will be willing to accept that average is the only choice our there because it isn’t the only choice. Even though the odds are against beating the market, funds still do it each year. This possibility is too enticing to completely pass up.

You don’t have to read this blog too long to find out that I’m a huge fan of passive fund management. Low fees and the guarantee to not do worse than the market is worth it to me. That being said I do own some active funds. In one sense it is an experiment of sorts. I’ve picked an active manager company who has had nearly a hundred years of success and I’m willing to see if they can beat the market in the future. If they don’t, most of my money is elsewhere. If they do, I’ll be glad I diversified my fund approach.

So how much of the market could index without running into trouble? Mr. Bogle believes that 75% would be alright and there wouldn’t be a significant risk at that level. Most crrent estimates don’t put the index market at even half that number. Interestingly enough, he said that ETFs are not included in his figures. He said that investors don’t buy and hold them like most do mutual funds.

The growth of ETFs this year has been nothing short of amazing. So far this year, 170 billion has flowed into EFT funds. Investors have been flocking to ETFs in droves and for good reason. Many times they have lower fees of comparable mutual funds and no minimum purchase amount. I personally buy ETFs all the time and I’m not day trading them either. I buy and hold them just as I would mutual funds. Even though ETFs can be actively traded with greater ease than mutual funds, it doesn’t mean you have to. Can and could doesn’t directly equate to will and would.

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