If the members of the thread won't mind a short diversion on this subject, I will explain my concern. It does involve the entire market psycology now, so there may be some import to this.
I have absolutely no problem with mutual funds. They have provided liquidity, money, and education for the public about the markets. That being said, I do have a concern about index funds.
In a standard mutual fund, a fund manager will have great flexibility in the companies he invests in. For instance, in a tech fund, the fund manager is not locked into Intel if he thinks its a bad investment. He can sell out of it anytime he feels like it. His performance in doing this is what seperates a successful manager from a poor one.
But an index fund has no flexibility.It is simply taking money and dividing it amongst a set number of companies in precise proportions to emulate the index they are copying. It cannot grow outward and incompass more companies, thus spreading out the money contributed to it. All it can do is put new money into the same companies in the same proportions. Thus you have an amount of money, recently very large, pursuing a set number of companies that can never change. Hence, you have limited supply and large demand. Price goes up. Valuations get way out of line. My reference to Coke is nothing I came up with. Last year CNBC paraded an entire host of analysts that thought it was overvalued, and several cited index funds the reason.
My major concern with this is that a large amount of retirment money has gone into these. Sure, there are a lot of stock savy investors like us out there. But I would be willing to bet if you asked 100 401K members to tell you about the fund they are invested in, they would have extremely limited knowledge of its make up, what it invests in,and who runs it. All they would care about is its returns. And since the returns are good due to the above arguement, they will continue to invest in the same funds.
What happens to these, usually Baby Boomers, when they are 64 and ready to retire if there's a market hiccup and they see their funds start to lose value. They aren't going to be contributing anymore since they are leaving the workforce, and why keep their money at risk. They will sell. Since these are a major driver in the major market, it will go down. More retirees see this and sell, and down the tubes we go.
In 1929, the average Joe on the street was heavily invested in the market. Sure, the 10% margin rule didn't help things, but the real culprit was that the average Joe didn't ever think things would go down. They just stuck their money into the market. When it did, all hades broke lose as they paniced out.
I think we may have a similar situation building, although not near as bad. But the psycology is there, and when a large amount of our population is invested in the market without understanding what they are investing in, I worry. Not now or maybe 10 years from now, but someday. |
