A Professor Who Was Right About Index Funds All Along

I'm going to use this as an opportunity to yet again rail against the idea of indexing. It's a good thing in theory, but like most things, when it's taken to extremes, it's horrible.

Passive investments wherein the investor takes zero interest in these investments are and have always been a terrible idea, and nothing in modern history has facilitated this more than index funds. When you give a friend of a friend $10,000 to start a company, do you just hand it over no questions asked and with no follow-up? Or do you try to get engaged with your investment? Make sure the CEO isn't sitting on his ass collecting a paycheck? Scrutinize it for potential frauds?

Well, that's what you do in an index fund. Except it's not even a friend of a friend that you're trusting. It's some group of people who likely live thousands of miles away who may or may not have an opiate or alcohol addiction or are complete sociopaths or are just regular humans who know how to legally take advantage of you when you aren't paying attention.

You want to know why CEO pay is so high? It's because CEOs have no accountability for raising their pay when investors aren't paying attention to what they're doing. You want to know why CEOs are taking short-term action to boost stock prices at the expense of long-term viability? It's because they care about the short, you care about the long, and you have no voice when you're in an index fund. You want to know why CEOs are issuing debt to do stock buybacks? To empire build by paying too much for their competitors? To play accounting games to boost short-term earnings?

Index funds are the tail that's wagging the dog, and they are going to be a disaster. And unlike derivatives, which can mess with stock prices but largely leave the fundamental structure of the company untouched, the dog that's being wagged here is the viability of globally important corporations that we depend on.

They were fine when 5% of the market just piggy backed onto the other passive (though attentive) investors. But now passive and inattentive investors are a massive proportion of the market.

I disagree.

For one thing, there are still plenty of active investors around. The fact that the less active investors around, the easier it is for them to make returns, will help the market stable and full of "enough" investors.

It is absurd to worry right now about not having enough finance professionals, considering just how many people are in the market.

In terms of what's best for a single person deciding where to invest money right now, indexing seems to provide the best opportunity. It's clear that most investors will not spend the requisite time tracking companies, nor should they considering the benefit of specialization.

I appreciate your opinion, but when I see that companies like JNJ are 67% owned by Mutual Funds and Institutional Investors[1], most of whom are low-cost and inactive, it tells me we've gone too far.

An I am not advocating for more finance professionals. Paying active managers to invest for you can cause the same problems I'm talking about. I'm advocating for personal responsibility and attentiveness.

[1] http://finance.yahoo.com/quote/JNJ/holders?p=JNJ

>When you give a friend of a friend $10,000 to start a company, do you just hand it over no questions asked and with no follow-up? Or do you try to get engaged with your investment?

That would depend on the company and the agreement we make on how I'll get compensated (will I own a %, etc)? That agreement is clear when investing in a fund. Once we have an agreement, my only concern is he/she keeps their end of the deal.

>Make sure the CEO isn't sitting on his ass collecting a paycheck? Scrutinize it for potential frauds?

Unless you're buying your own stocks, this is a potential problem with every fund, not just index funds.

Precisely by being an investor in the old sense, the sense of being a businessman who allocates capital. He buys entire companies based on his analysis of their financials and management, and then operates them as businesses. He tries to take stakes in companies in deals where he holds an advantage, such as his Goldman Sachs investment. I don't consider him a stock picker, he's a very shrewd businessman.