On August 31, 1976, John C. Bogle of Vanguard launched the first index fund available to individual investors. From that point, the benefits of spreading investments across a broad swathe of stocks to both limit risk and maximize gains (at a bare minimum of expense) were available to regular people, not only to large institutional investors.
After 50 years, the advantages of passively managed index fund investing versus active management (in other words, a human being picking stocks for you in order to try to outperform the market) are varied and undeniable. Since the livelihoods of thousands of very well-paid people depend on investors believing that someone sufficiently qualified can consistently outperform the market, it is a bit difficult to find hard data on this, but one recent report that is in line with plenty of others I’ve digested over the years found that market indexes outperformed over 80% of actively managed funds across every single category of domestic funds.
Furthermore, the expense ratio (what percentage of your total investment your brokerage firm will charge you per year) for actively managed funds often approaches 1%, whereas it can more typically be 0.05% or less for many passively managed index funds. A single percent doesn’t sound like much, but given what it costs you in compounding returns over a lifetime, the difference between 1% per year and next to nothing per year will easily mean a difference for even a modestly heeled investor of hundreds of thousands of dollars. That’s a lot to pay to lose to the market, especially when the generally higher tax burden of active fund management is factored in.
So, the choice is abundantly clear for most individual investors. If you want to make more money, you should probably invest in passively managed index funds.
All that being said, today index fund investing does face more challenges than just human beings liking to think that we have more personal control over things than we do. Half a century since their inception, there are several legitimate concerns about the viability of broadly available index funds.
Meme stocks, for instance, are basically the cryptocurrency of the stock market. Based on nothing beyond a surge of people buying into it (or rushing to sell it), a meme stock’s share price has virtually no relationship to the company’s underlying financial performance.
As long as meme stocks stayed at the periphery of the market, they weren’t hurting anyone beyond those who deliberately opted in. Now, with the mother of all meme stocks SpaceX set to be included in a number of major stock indexes (which would mean it would also automatically be included in passively managed funds tracking those indexes), it does seem like there could be some merit to a fund that would sort the chaff out. In today’s market, it might not be advantageous to dogmatically buy in to, say, the entire list of the 100 biggest publicly traded companies no matter what.
Closely related to the meme stock phenomenon is the increasingly credible idea that we are in an artificial intelligence stock market bubble. Many tech stocks (and even a few decidedly nontech ones) have been behaving more and more like meme stocks, with share prices surging due to nothing more than inclusion of the letters “AI” in their names, or with a token nod to artificial intelligence utilization in an earnings call and the quarterly report.
Billions are still being plowed into AI development, but with many American consumers decidedly against the technology and CEOs consistently unable to financially justify their massive AI investments in the absence of lofty promises of future profitability, it’s hard to picture that all of the AI companies escape reaping what they are currently sowing. So, there could be money to be made by anyone willing to front-run the AI stock market crash, should there come to be one, much like a few people successfully predicted and profited off of the 2008 subprime mortgage crisis.
Lastly, today’s index fund investors are additionally exposed to what sure seems to be stock market manipulation by President Donald Trump himself and/or by those close to him. Trump disclosed 3,642 stock trades in his investment accounts during the first quarter of this year. These trades concerned hundreds of millions of dollars in securities and included stock in companies that have extensive business with the federal government.
Trump has denied any wrongdoing, though it is awfully suspicious that so many of his market-moving announcements are timed to coincide with what he would prefer to see the stock market do. If Trump or anyone else is trading on insider information to profit off of stocks contained in your index fund, that is costing you a little slice of your performance every time it happens.
If you could find an investment firm that could successfully filter out the meme stocks, correctly weight the overly pumped up AI stocks, and somehow shield you from what could be federal stock market shenanigans, that might be enough to justify the cost. I’m dubious anyone accessible to individual investors can do that.
While we are now facing a number of novel risks to index fund investing, for the average individual investor, I still don’t see a better option. Perhaps we’ll be best served by sticking to it for another 50 years.
Jonathan Wolf is a civil litigator and author of Your Debt-Free JD (affiliate link). He has taught legal writing, written for a wide variety of publications, and made it both his business and his pleasure to be financially and scientifically literate. Any views he expresses are probably pure gold, but are nonetheless solely his own and should not be attributed to any organization with which he is affiliated. He wouldn’t want to share the credit anyway. He can be reached at jon_wolf@hotmail.com.
The post 50 Years In, Index Fund Investing Risks Include Meme Stocks, The AI Bubble, And Presidential Market Manipulation appeared first on Above the Law.
On August 31, 1976, John C. Bogle of Vanguard launched the first index fund available to individual investors. From that point, the benefits of spreading investments across a broad swathe of stocks to both limit risk and maximize gains (at a bare minimum of expense) were available to regular people, not only to large institutional investors.
After 50 years, the advantages of passively managed index fund investing versus active management (in other words, a human being picking stocks for you in order to try to outperform the market) are varied and undeniable. Since the livelihoods of thousands of very well-paid people depend on investors believing that someone sufficiently qualified can consistently outperform the market, it is a bit difficult to find hard data on this, but one recent report that is in line with plenty of others I’ve digested over the years found that market indexes outperformed over 80% of actively managed funds across every single category of domestic funds.
Furthermore, the expense ratio (what percentage of your total investment your brokerage firm will charge you per year) for actively managed funds often approaches 1%, whereas it can more typically be 0.05% or less for many passively managed index funds. A single percent doesn’t sound like much, but given what it costs you in compounding returns over a lifetime, the difference between 1% per year and next to nothing per year will easily mean a difference for even a modestly heeled investor of hundreds of thousands of dollars. That’s a lot to pay to lose to the market, especially when the generally higher tax burden of active fund management is factored in.
So, the choice is abundantly clear for most individual investors. If you want to make more money, you should probably invest in passively managed index funds.
All that being said, today index fund investing does face more challenges than just human beings liking to think that we have more personal control over things than we do. Half a century since their inception, there are several legitimate concerns about the viability of broadly available index funds.
Meme stocks, for instance, are basically the cryptocurrency of the stock market. Based on nothing beyond a surge of people buying into it (or rushing to sell it), a meme stock’s share price has virtually no relationship to the company’s underlying financial performance.
As long as meme stocks stayed at the periphery of the market, they weren’t hurting anyone beyond those who deliberately opted in. Now, with the mother of all meme stocks SpaceX set to be included in a number of major stock indexes (which would mean it would also automatically be included in passively managed funds tracking those indexes), it does seem like there could be some merit to a fund that would sort the chaff out. In today’s market, it might not be advantageous to dogmatically buy in to, say, the entire list of the 100 biggest publicly traded companies no matter what.
Closely related to the meme stock phenomenon is the increasingly credible idea that we are in an artificial intelligence stock market bubble. Many tech stocks (and even a few decidedly nontech ones) have been behaving more and more like meme stocks, with share prices surging due to nothing more than inclusion of the letters “AI” in their names, or with a token nod to artificial intelligence utilization in an earnings call and the quarterly report.
Billions are still being plowed into AI development, but with many American consumers decidedly against the technology and CEOs consistently unable to financially justify their massive AI investments in the absence of lofty promises of future profitability, it’s hard to picture that all of the AI companies escape reaping what they are currently sowing. So, there could be money to be made by anyone willing to front-run the AI stock market crash, should there come to be one, much like a few people successfully predicted and profited off of the 2008 subprime mortgage crisis.
Lastly, today’s index fund investors are additionally exposed to what sure seems to be stock market manipulation by President Donald Trump himself and/or by those close to him. Trump disclosed 3,642 stock trades in his investment accounts during the first quarter of this year. These trades concerned hundreds of millions of dollars in securities and included stock in companies that have extensive business with the federal government.
Trump has denied any wrongdoing, though it is awfully suspicious that so many of his market-moving announcements are timed to coincide with what he would prefer to see the stock market do. If Trump or anyone else is trading on insider information to profit off of stocks contained in your index fund, that is costing you a little slice of your performance every time it happens.
If you could find an investment firm that could successfully filter out the meme stocks, correctly weight the overly pumped up AI stocks, and somehow shield you from what could be federal stock market shenanigans, that might be enough to justify the cost. I’m dubious anyone accessible to individual investors can do that.
While we are now facing a number of novel risks to index fund investing, for the average individual investor, I still don’t see a better option. Perhaps we’ll be best served by sticking to it for another 50 years.
Jonathan Wolf is a civil litigator and author of Your Debt-Free JD (affiliate link). He has taught legal writing, written for a wide variety of publications, and made it both his business and his pleasure to be financially and scientifically literate. Any views he expresses are probably pure gold, but are nonetheless solely his own and should not be attributed to any organization with which he is affiliated. He wouldn’t want to share the credit anyway. He can be reached at [email protected].
