Actual ways in which a large Index Fund / ETF could "blow up"

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IlliniDave
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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by IlliniDave »

bryan wrote:
Wed Jun 21, 2017 4:10 pm
add emphasis on funds but really it's not the case. The funds are implementation defined methodology whereas the index methodology itself is defined and is used as the benchmark for tracking error for the funds. I admit I don't dig into the stuff in depth/breadth though.

> but they aren't lists of someone's hot stock tips in general

Why shouldn't they be?
I suppose they could but hot stock tips seem to change every week or month so a fund tracking an index that did that would defeat the whole premise behind index funds and would make them no different than any actively managed mutual fund or large portfolio. When you dig into index funds one of the hallmarks is exceptionally low turnover.

bryan wrote:
Wed Jun 21, 2017 4:10 pm
Again, (the biggest) index funds are only useful since they combine "total market performance" (debatable, but I submit for now given "gravity of capital" effect i.e. mo' money, even mo' money) with low fees. Indexes I suppose are in charge of the former whereas the funds the later. Why shouldn't there be boutique indexes?

I'm not sure if there is a metric that combines fund fees w/ tracking error to come up with actual cost/performance?
Going back to VTSAX, the fund owns nearly 3,600 publicly-traded US stocks, cap weighted. How can it not track total market performance? It is structured to be a detailed scale replica of the total market. With ER of 0.04%, practically no transaction costs (turnover < 5%), no 12b or other fees, it's tracked the total market within .01% (net of fees) since it was launched 17 years ago. It is not an outlier among index funds from any provider that I am aware of.

I don't think there is such a metric. Fees lower the return to investors dollar-for-dollar so that's reflected in performance data. Tracking error is interesting but not of enough interest to investors that it gets much publicity (but it is typically reported implicitly by comparing results to the benchmark index). Morningstar has mined their data to show that performance tends to be inversely proportional to fees. Vanguard published data annually showing where their funds' performance stacks up against other funds in the same Morningstar category.
bryan wrote:
Wed Jun 21, 2017 4:10 pm

I agree there is a lot of stabalization thanks to index fund popularity. But I also think in the event of a downturn the diversification touted of an index will evaporate. You will want a strategy for this case. Maybe it means owning gold, bonds, cash, or shares in a hedge fund. I think hedge funds (or active funds) are underrated today (bunch of losers!).
My opinion: the stability comes from the personality of index investors on the whole (which includes a lot of institutions and endowments). They are not out to make a quick buck, they are generally playing the long game, and stay positioned such that they believe whatever they might lose in the short/medium term, they can afford to wait for eventual recovery.

I would say index fund investors who invest 100% in stocks are a significant minority. Most of them have healthy bond positions (often also index funds, btw), some amount of cash (both largely depending on where they are relative to retirement), and occasionally a commodity like gold. Despite the popular narrative, for the most part they are not stupid people who are ignorant of the risks inherent to investing in stocks.[/quote]
bryan wrote:
Wed Jun 21, 2017 4:10 pm
> Academic theories will not save anyone either.

?
I'll send the "?" back to you: you' made a comment about whether EMH would save index fund investors, implying they expected it to. Half of them don't even agree with the EMH, much less believe it would somehow shield them from the vagaries of the stock market..

.
bryan wrote:
Wed Jun 21, 2017 4:10 pm

Excellent! I've always thought it's dubious to pretend like we had index funds in the past. Thus many FIRE/investment portfolio calculators are also dubious. Much more interesting to have a calculator that is more like "follow the (smart, middle-class) crowd for investment decisions"; in the last decade the crowd is saying "buy index funds". Maybe a decade from now the crowd is saying buy AppleTokens. Some assets just aren't available to an average middle-class investor through time. Sounds like a project for @Tyler9000..
I don't think anyone does pretend that index funds have existed forever. As far as calculators, that's all sort of related to history. Indexes were originally intended to be metrics that would measure movements the stock markets (or segments of the stock markets). When mutual funds came into existence, the accepted indices were a natural standard by which to measure fund management's performance. When it became apparent after several decades that in the aggregate mutual funds returns received by investors lagged the indices consistently over time (typically the SP500 was the accepted benchmark), and thereby the accepted measure of the market itself, a few people got the idea that, "Heck, if we just hug the SP500 our clients would be much better off." And so index funds were born. It's just a coincidence in a sense that the best, most accessible, historical performance data we have is the SP500, making an SP500 index fund a natural pair when trying to extrapolate with that data. I agree that there are risks involved in trying to predict the future based on the past. But whatever the SP500 does, someone owning an SP500 fund will match it pretty closely.

I think some of the confusion comes from thinking that people who invest in index funds see it as a materially different action than investing in the stock market via some other vehicle (active mutual funds, personal portfolios of individual stocks, or even derivatives). It's just a no-nonsense vehicle to get direct exposure to equities. Traditionally the goal was "to beat the market". For index investors the goal is modified to "match the market."

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by jacob »

@ThisDinosaur - In your response to iDave there's the assumption that individual investors' goal is to set fair prices; as if they are all value investors or some such. (As per the original assumption when the EMH was formulated in the 60s... when that was actually more or less the case, value-investing being hugely popular.) That's not true now. Some are momentum investors jumping on issues that are rising hoping to get out once the price has gone up. Some will deliberately try to "ignite" momentum to get others to jump on. The greater the fraction of dumb money, the easier it gets to play these games.

In general, there's a lot a fund can do to avoid catastrophic tracking-error. If a major index experiences a big move either up or down, they could immediately hedge in the futures market. Dow, S&P and Russell are all very liquid---except in flash crashes. Also, I would expect a bail-out. Where the issues discussed in this thread are an issue is mainly for podunk ETFs like "Junior Argentinian Biotech"-ETF or somesuch. There's a lot of that stuff around. The popularity of ETFs (or any financial product really) attracts companies willing to offer anything to the market. Retail investors buy those mindless thinking they're better.

Because of the arb ... if most people buy and sell ETFs ... then THAT is what drives the price of all the basket issues. In that case, diversification is null and void. This is call market-risk. If 100% of people were trading index funds, then the risk would be 100% market-risk and 0% company risk. Diversification does NOTHING to alleviate market risk

Asset allocation (and rebalancing) is meant to reduce stockmarket risk by diversifying into other asset classes.

However, that creates the exact same problem just one level removed. (Professionals already trade against this effect. It's predictable because people (balanced pension fund managers, like target date, tend to rebalance around the paycheck days when loads of cash comes in automatically and needs to be allocated.)

The deciding issue here is _strategy diversification_. As buy&hold indexing has exceeded 50% of market cap ... that kind of diversification goes down. This means there are fewer people willing to take the other side of the trade. This means faster crashes and jumps and more volatility.

The thing is ... that tracking-error has a constant cost (which fund managers try to minimize). During crashes that cost can be higher.

In your examples, you're not thinking symmetrically. Any price out of whack is bad. The question is who eats the difference between the ETF and the stocks that it represents when the trade that balances the companies books actually happens. If the company losses, then that loss is reflected in the NAV for all holders of that fund. So it doesn't matter if you don't personally trade. In general, fund companies hire experts to minimize tracking errors, so it's not an issue. However, tracking errors are a constant cost... in case of a big crash, it could get bigger ... but you'd probably be more sad that you lost -10.15% because the market went down than the fact that the number was 0.03% off and should have been -10.12% because the volume was so high that the fund company's traders couldn't keep up.

Those 0.03% would represent a permanent loss to you, however. They were smoked and lost [by the fund company] in the crash. If you held the individual stocks, you would still have them at a lower price, so at -10.15%. If the market went up tomorrow, you'd be back to 0%. Whereas the fund would be down -0.03% ... or maybe they'll add them to the fee as a cost of doing business. THAT is the cost of tracking error.

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by ThisDinosaur »

First, I don't understand the mechanism of momentum. The only explanation I can come up with that makes sense is that it represents news traveling slowly through the investor population. Value investing makes sense to me as a concept. #NarrativeFallacy

Second, I see that diversification into a set of insanely popular asset classes doesn't alleviate market risk. But how does a market catastrophe caused by index fund hubris not take down every other investment style with it? (I am anticipating that your answer to this is to invest only in cash flow from issuers likely to survive a crash. What other styles would survive?)

Dragline
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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by Dragline »

Things that are negatively correlated with stocks would make money in the index fund crash environment -- like long-term treasury bonds. Panic assets like gold would probably also do pretty well. Even the dollar itself. You are correct that so-called diversification among positively correlated assets is not really diversification in crash scenarios.

The mechanism of momentum is "monkey see, monkey do." You are watching it in action right now with the crypto-currencies. People hear stories about other people making money and decide to get on board. It becomes self-perpetuating until all passengers are on board. Then the train stops and sometimes derails.

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by ThisDinosaur »

@Dragline
Correlations are transient. The "insanely popular asset classes" I'm referring to include bonds and gold. I was referring to Jacob's frequent argument that passive Asset Allocation as a strategy could collapse if it becomes too popular.

Example scenario; Stock market crashes, and all the other passive investors start selling gold and bonds to rebalance before you do. Simultaneously, a bunch of scaredy cats go straight to cash under the mattress. By the time you log into your broker, there are no buyers for you to sell any equity or non-equity securities to.

If that's the scenario, I'm asking what investment style could survive that. My guess is 1)smart/lucky cash-flow only investors, 2)smart/lucky market timers, 3)private equity/rental real estate investors, 4)cash stash/physical gold bugs, 5) And, I guess Homesteaders/subsistence farmers for good measure. Mostly, just staying out of the market all together.

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by jacob »

Most assets are highly leveraged at the professional level. While retail investors are required to post 50% margin, big investors can post as little as 3-5%. This means that they can control $1,000 worth of stock for $30 (borrowing the other $970), whereas you and I would need to put down $500 (and borrow the rest). Most retail investors (and funds, except some closed-end ones) put down the full $1000.

I forget what the required margin to post is for treasuries. The rules are [way] more complicated because you're allowed to pair off long and short positions with similar maturation and only post margin for the difference. This means you need even less money. Note that this rule does not in any way account for any kind of yield curve gymnastics or liquidity issues that might arise. As noted above, bonds are less liquid that stocks.

When markets crash, margin calls come in right and left and people are forced to cover. The only way they can raise cash is by selling assets that have gone or are going up. This flips the correlations and THIS is why anti-correlated assets don't protect against crashes. Note that one needs to sell a lot of "safe" assets to cover the other 97%.

The only winners here are those who already sit on cash or who have less leverage and can reduce their risk before others. They essentially have a chance to short-squeeze the more exposed participants.

Under normal circumstances when people can raise cash in a good and orderly fashion or don't get market calls, the anti-correlation holds. It is the basis for the Fed Model as well as the more modern (QE-era) "risk on/risk off" narrative with traders moving between equity and treasuries primarily via the futures market with everybody just along the ride because these guys are massive. It's the tail (professionals) wagging the dog (retailers and pension funds). The loss/gutting of Dodd-Frank is going to make things more "interesting" again.

"Momentum" is simply buying the trend and hanging on for a while before selling hoping that others will do the same. "Momentum ignition" is trying to start a trend and trigger enough people to propagate the trend. I think it's fair to say that all bubbles (positive feedback runaways) are based on momentum. If one's reason for buying something is that "it will keep going up because it's previously been going on", then one is a momentum player at some time-scale. Contrast this with a mean-reversion (negative feedback) player who will "buy it because it's gone down and sell it because it's gone up".

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by jacob »

Going back to the OP's original question:

Can equity funds or bond funds blow up in the technical sense (e.g. fund company going bankrupt). Sure. It's possible but extremely unlikely. A major one would likely receive a bailout because it's pretty clear than politicians don't really believe that decisions should have consequences when it comes to Wall Street. An index fund it very very hard to blow up since their alpha is zero and beta is 0 almost every dimension (depending on how representative their basket is). The fund itself have very very little risk exposure. They make their money by charging fees to their holders. (Recall how they're long short in matching positions, 1-1=0). The owners of the fun shares of course have alpha=0 and beta=1.

Can equity funds or bond funds enter a severe correction. Sure. It's even possible they could enter a permanent correction and never (not after many decades anyway) come back up again. Nikkei225 for example. It's possible that humans would lose interest in equity altogether. After all, it's not more than 75-100 years ago since equity ownership was rare (a small minority of the population). It could be so again. It is currently so in many countries. All this takes is essentially a new tax law that hates stocks---maybe to be introduced once the non-stock owning part of the voters gain a majority? Ditto with the treasury market insofar certain foreign countries (you know who they are) stop saving their wealth in the bonds of other countries and start saving it in their own. It's also possible to run into a permanent stall/plateau insofar the desire to just throw money at the US capital markets run out of buyers. In Europe, it was (is?) possible to sell bonds at negative interest rates simply because funds were forced by regulations to buy them. Imagine that. Take gun, aim at foot, shoot. Maybe some people will argue for American Exceptionalism here?

Can the current dominant strategy cause other problems? Sure. Insofar nobody cares to price securities accurately anymore, it means that all companies now get capital financing at average rates. This means that good companies pay too much for equity financing and shitty companies pay too little. This would cause a grind of malinvestments and make the US economy less competitive as long as this condition persists. Since there will be no alternate universe to compare it to, it would simple be the new normal as widely ignored as more and more use the capital markets as their retirement savings account expecting it to pay higher interest rates [because history] ... except it won't because of the above reasons. (Try to imagine what the housing market and the economy would have looked like today if there hadn't been a housing bubble caused by too cheap money. At the same time, try to figure out what the SP would have traded at in that universe. Higher? Lower? Keep in mind that QE would not have happened in that universe. So strangely, w/o a housing bubble it's conceivable that the stock market would actually have been lower today. Crazy, no?)

Could things keep going up without exploding? Sure. QE proved that it's possible to goose the equity markets to over 100% above normal valuations simply by giving banks cash(+) ... and everybody played along. So why not 150% or 200%(*) more? Insofar the stockmarket can be kept apart from the regular economy (milks and eggs) ... there will be no inflation in the regular market. This split into finance-dollars and street-dollars surprised a lot of old people.

(+) Technically that was not exactly how that happened, but practically it was.
(*) Partying like 1999-2000.

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Seppia
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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by Seppia »

Thanks again Jacob and all others for the responses.

One thing: it is true that indexes account for large % of ownership of stocks (this phenomena is significantly more pronounced for the USA market btw, in Europe indexing is much less prevalent), but due to the nature of the beast they account for a much smaller percentage of the trading.
This should reduce the index funds impact on price setting.

Also worth noting: it seems like most of the actively managed mutual funds have been doing mostly "closet indexing", because they're incentivized to do so by being compared to the benchmark at all times.
It makes sense and it would explain why they vastly underperformed index funds in the last 15-20 years (they're doing the same only with higher fees).

So in term of "bubble creation" I don't see huge differences between index funds and any other way.
It's just the product of a situation where people are overly optimistic on the future.

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by fiby41 »

It's just the product of a situation where people are overly optimistic on the future
or have high liquidity.

IlliniDave
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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by IlliniDave »

Seppia wrote:
Thu Jun 22, 2017 5:47 am

Also worth noting: it seems like most of the actively managed mutual funds have been doing mostly "closet indexing", because they're incentivized to do so by being compared to the benchmark at all times.
It makes sense and it would explain why they vastly underperformed index funds in the last 15-20 years (they're doing the same only with higher fees).
This is correct, especially for larger mutual funds.

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by 7Wannabe5 »

bryan said: Raising capital in this day and age of low interest rates and a shrinking middle class (and especially the near future with "blockchain" securities) is pretty easy via private channels.
jacob said: Can the current dominant strategy cause other problems? Sure. Insofar nobody cares to price securities accurately anymore, it means that all companies now get capital financing at average rates. This means that good companies pay too much for equity financing and shitty companies pay too little. This would cause a grind of malinvestments and make the US economy less competitive as long as this condition persists.
This is what I was trying to get at with my Farmer's Market analogy. As capital financing becomes increasingly easy for companies with a seat at the table, they will naturally tend towards becoming less involved in actually producing/providing goods/services/materials and more engaged in "just" marketing/network-formation/finance themselves. IOW, when you buy shares of these companies on the market, you are really just buying shares of subsidiary markets, because theses companies are tending towards mostly just functioning as markets and capital lenders for smaller producers and sub-contractors. However, it seems to me that there will eventually be a limit where small producers/providers will balk or fold under the stress of lopsided share of risk/rate burden. The hot potato in the game being in the lap of whomsoever actually produces/provides services and goods or maintains tools of production.

For example, who is regulating/insuring high interest loans for suitable vehicles a company like Uber might offer to 1099 drivers who are operating in competitive market with no minimum wage bottom?

IlliniDave
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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by IlliniDave »

ThisDinosaur wrote:
Wed Jun 21, 2017 9:40 pm

Example scenario; Stock market crashes, and all the other passive investors start selling gold and bonds to rebalance before you do. Simultaneously, a bunch of scaredy cats go straight to cash under the mattress. By the time you log into your broker, there are no buyers for you to sell any equity or non-equity securities to.

If that's the scenario, I'm asking what investment style could survive that. My guess is 1)smart/lucky cash-flow only investors, 2)smart/lucky market timers, 3)private equity/rental real estate investors, 4)cash stash/physical gold bugs, 5) And, I guess Homesteaders/subsistence farmers for good measure. Mostly, just staying out of the market all together.
First you'd have to define "survive" and have specific goals in mind. That scenario is easily survivable by a 25-year-old who plans on working until retirement age (40+ years down the road) with conventional investing approaches. If stock prices plummet their dividend yield will go through the roof (provided this isn't yet another economic Armageddon thought experiment) and at some point people will buy back in and prices will normalize. But for someone who is already retired, time is not their friend, and about the only strategy that has a high probability of surviving such an event while meeting the retiree's needs is to go into the situation with minimal exposure to equities.

It really goes back to the old truism that when you invest, you get paid to take a chance of losing some or all of your money. In other words: no risk, no reward. If your investing outlook is centered on preparing for disastrous situations, don't put more money at risk than you can afford to lose (probably not bad advice for a more optimistic investor like myself either).

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by bryan »

IlliniDave wrote:
Wed Jun 21, 2017 6:05 pm
bryan wrote:
Wed Jun 21, 2017 4:10 pm
Again, (the biggest) index funds are only useful since they combine "total market performance" (debatable, but I submit for now given "gravity of capital" effect i.e. mo' money, even mo' money) with low fees.
Going back to VTSAX, the fund owns nearly 3,600 publicly-traded US stocks, cap weighted. How can it not track total market performance?
Define market. VTSAX doesn't have much exposure to small business/startups (or other private companies) or international companies; except by way of inter-connectedness and second order effects etc.. Maybe if you could buy shares in the One World Government that collects taxes (or the major currency of the world was digital with taxes built-in and there was a corresponding share that pays out the tax revenue) it would represent the total market. Today it's very difficult to get exposure to a lot of markets that are out there.


> I'll send the "?" back to you: you' made a comment about whether EMH would save index fund investors, implying they expected it to. Half of them don't even agree with the EMH.

I mean EMH in the sense that arbitragers gonna arbitrage. Setting prices and all that. Of course it's not always the case due to reasons like 1) information asymmetry 2) illegal to arbitrage 3) mass of dumb money is just too much, overwhelming 4) not worth the cost (time, effort, capital) exacerbated by information asymmetry, etc. EMH might save indexers in the sense that the securities continue to be accurately priced, I guess? I think I was also thinking of some arbitrage happening between stocks in an index versus not in an index..

I've never agreed with EMH, as I understand it, for at least the reasons I list above (basically that we are not all omniscient/omnipotent beings with unlimited energy etc). Maybe I just haven't cared to learn what it really means..

> I don't think anyone does pretend that index funds have existed forever. As far as calculators, that's all sort of related to history. Indexes were originally intended to be metrics that would measure movements the stock markets (or segments of the stock markets).

Calculations (and conclusions/writings and folks reading and taking subsequent actions) that rely on looking at the index before you could easily/cheaply mimic the index in your own portfolio is worth very little. I am not sure how the calculators consider costs of investing (not just trading fees!) over time and how they predict those costs into the future (hopefully those costs follow a trend-line? or more likely the calculators just ignore this stuff completely.). Also, you have to consider the historical accessibility of something i.e. did the median American have reasonable access to trade in it.

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by brighteye »

I am not even trying to join the conversation since I still have a lot to learn. But I liked this presentation of Steven Bregman, mentioned in Jesse Felders podcast:
http://www.grantspub.com/files/presenta ... nal[2].pdf
Just one quote from the slides, tell me what you think:
"As the saying goes, once everyone’s in, there’s only one place to go.
One would do well to remember that this state of affairs is not a new phenomenon. In prior eras, it was known
as go-go investing, or trend following. Now it takes the guise of index-based asset allocation. All such phenomena
have ended unpleasantly. The index universe has become, simply, a big momentum trade (or, perhaps, an interest rate momentum trade). It is the
most crowded trade in the history of investing. And crowded trades eventually attract short sellers."

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by jacob »

I should also mention that in relation to crashes (and here I mean intraday), if something screwy is detected, two things generally happen.

1) Algorithms pulls their quotes. Since algos comprise about 90-95% of all orders in the market(*), the market suddenly becomes very thin. This means that large sell orders will fall through the floor. This means that the block creating/redemption mechanism is not guaranteed by zero-arb if the market is moving rapidly. The reason is that it's too hard/risky to trade, so people simply don't because they're not obligated to do so. (Market making is no longer done by actual market makers.)
2) Since 2010 or so, exchanges have installed circuit breakers that halt or even revert all trading if the price drops 10% within X time. (It might not be exactly 10% but it's something on that order.) This was done because people (especially those placing market orders) would get absolutely creamed if they happened to put in a market order right on top of a drop. Imagine wanting to sell your 200sh of PG and find that they got filled at $56 :shock:

(*) This lack of overhead + concentration is why modern spreads are often down to half-cents (used to be a quarter or more); execution is nearly instant; and fees are low or $0. (For some professionals, fees are even negative---getting paid to provide liquidity by taking on the risk of a position. This incidentally, is how those $0 fee brokers make their money.) It's somewhat ironic that some people complain about HFT while at the same time praise the low fees they're paying for market access.

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by ThisDinosaur »

@brighteye Thanks for the link.

I shouldn't be surprised at this point that Jacob seems to be so damn right all the time. But I still have some fear about choosing individual securities instead of diversified funds. Epistemologically, I have know way of knowing which quadrant I'm in:
1) Those who know that they can beat the market.
2) Those who know that they can't beat the market.
3) Those who don't know yet that they can beat the market.
4) Those who don't know yet that they can't beat the market.
It was arguments from Index Fund Enthusiasts that convinced me to start managing my own money to begin with, instead of punting to "advisors." Since then, I've learned a lot, but I still see a lot more risk in owning 20 stocks than in owning damn near all of them. If you want to own income-producing assets, risk of ruin likelihood goes 1)personally held business, 2)handful of carefully picked securities 3)almost all publicly traded securities. I don't see any way around this.

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by IlliniDave »

bryan wrote:
Fri Jun 23, 2017 3:34 am


Define market. VTSAX doesn't have much exposure to small business/startups (or other private companies) or international companies; except by way of inter-connectedness and second order effects etc..
Sigh. In the context of VTSAX (and SP500) market = US stock market. In the context of mutual funds it's the universe of shares in publicly-traded corporations in the US that have enough outstanding shares that they can readily be bought and sold**. For simplicity think NYSE+NASDAQ. It excludes anything that is not a stock in a corporation traded publicly in the US. So pork bellies and collectible autographed baseballs and private businesses and non-US stocks are not included in it.

It's good that you are thinking about things, challenging them, and asking questions. I would suggest doing a fair bit of reading, including a good dose of stuff that comes from a library or bookstore rather than the internet. It's pretty clear your understanding of index funds is a little jumbled (or perhaps mine is), and if we can't even use a term like "the market" in a conversation about index funds, the SP500, and VTSAX, without it leading to confusion, the conversation won't be productive.

Good luck.

**Some of the smaller microcap/nanocap stocks are avoided by most mutual funds because their liquidity is unsuitable. There are a few funds that specialize in them but the performance of the funds is generally regarded as not so good as or the most part fund returns significantly lag the performance of the stocks they hold.

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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by IlliniDave »

ThisDinosaur wrote:
Fri Jun 23, 2017 9:19 am
@brighteye Thanks for the link.

I shouldn't be surprised at this point that Jacob seems to be so damn right all the time. But I still have some fear about choosing individual securities instead of diversified funds. Epistemologically, I have know way of knowing which quadrant I'm in:
1) Those who know that they can beat the market.
2) Those who know that they can't beat the market.
3) Those who don't know yet that they can beat the market.
4) Those who don't know yet that they can't beat the market.
It was arguments from Index Fund Enthusiasts that convinced me to start managing my own money to begin with, instead of punting to "advisors." Since then, I've learned a lot, but I still see a lot more risk in owning 20 stocks than in owning damn near all of them. If you want to own income-producing assets, risk of ruin likelihood goes 1)personally held business, 2)handful of carefully picked securities 3)almost all publicly traded securities. I don't see any way around this.
I'm probably either in 2 or 3, but like you have no way of knowing, so just equaling the market seems a reasonable approach, as it will almost certainly land me in the top half of the class.

Someday I might put together a play portfolio of individual stocks just to test myself (current favored strategy is to equal weight a random selection out of the SP500), but for a guy less than 2 years from retirement who hopes to spend a good chunk of his future off-grid, putting it all in a self-managed portfolio of individual issues, especially if it involves a fancy derivative arrangement, doesn't make sense. "Beating the market" is unnecessary to me, and since it adds risk, possibly cost, takes up time, and doesn't fit my lifestyle, I've judged it not worthwhile for me. I'll just continue to ratchet down my relative exposure to stocks, continue oversaving (while I'm working), and hope I don't paddle out of the wilderness one day into a mid-Apocalypse world.

ThisDinosaur
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Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by ThisDinosaur »

The only reason "beating the market" is worthwhile is if there is significant concern that returns of the market will be inadequate and/or negative.

bryan
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Location: mostly Bay Area

Re: Actual ways in which a large Index Fund / ETF could "blow up"

Post by bryan »

@IlliniDave I think you've misread me or I've done a poor job at representing what I am trying to say. Obviously an S&P 500 index fund can do a pretty good job of tracking the S&P 500 index. I don't agree with the definition of "the market" (as people use the term in the personal finance investing sense e.g. "just capture the market since most active managers can't beat it! Save fees!") as being the "CRSP US Total Market Index" or even the "FTSE Global All Cap Index"; I would like to be explicit, as necessary (and I think it is worthwhile in this case). I think Jacob and others and other threads and articles have made some points more clearly, even if it is off topic to OP. Anyway, I will go back to ceding the point, for this thread, that there exists some index fund that tracks what people really mean when they talk/assume things about market returns.

Index Investing is starting to feel like paying into social security for the last couple years.. but again that has nothing to do with tracking error.

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