"If everybody indexed, the only word you could use is chaos, catastrophe...The markets would fail." - John Bogle, May 2017
Ask yourself why John Bogle, the creator of the first index fund, would say such a thing. He said this in May of 2017, and died in January of 2019, so we can only try to guess why the founder and CEO The Vanguard Group saw index funds as a phantom menace.
Perhaps there are several reasons for his dire warning:
- A false sense of diversification for the investor would lead to complacency. Consider the S&P 500 Index. You think you have 500 or more stocks. And you do. But most of your money and performance are dictated by the top 5 stocks. Microsoft, Apple, Google, Amazon, and Facebook hold more of your money and predict your performance.
- Index funds reward stocks for being large and in the index. One of the invectives hurled against capitalism is that the rich get rich and the poor get poorer. Well that's true of the heaviest weighted stocks in their respective indexes. A great small company does not get the same fund flows towards its stock because it's not already the biggest.
- Index funds passively give price support and maybe price distortion to bad stocks. The idea is that a good company should be rewarded by a higher share price. However, a bad company could ride the coattails of an index, basking in the price support of all those passive investors dumping money blindly. Furthermore, individual stock pickers on Main Street are tempted to ignore value or fundamentals and just assume price momentum means quality.
There's a few other reasons I'll share with you personally if you'd like to book some time on my calendar. Suffice it to say our current situation started with academic studies. These studies lead to a philosophy and approach to investing that has worked well. This approach has grown to a point where we have to revisit the prophecies of John Bogle. To learn more click here.
Related: A Do-it-Yourself S&P 500 Valuation