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>but am curious as to what the arguments against it are There's a "philosophical" problem to the effect of, at some point, what are you indexing? But what seems to me to be the more practical issue, and forgive me for this being half-formed, is that it seems like indexing is subtly the wrong thing to do (in a world consisting of only bad choices). The things being indexed are basically weights, for example, the relative capitalization of various stocks, based on some filtering criteria. In order to keep a fund on target with an index, they have to buy and sell according to those weights, and in principle, if the weights change, then the fund's holdings have to change accordingly. This would seem to me to introduce problems like, if there's a sell-off of some stock so that its price drops, then its capitalization will also drop (capitalization being number of shares times price per share), which would seem to reduce its weight in the index. This should then lead to index funds having a follow-on sell-off. (And likewise for exuberant buying.) So this would suggest to me that, if index funds come to dominate stock holdings, then they should both increase volatility, and result in their holders systematically "buying high and selling low." That is, because an index fund is not the same as an index, but it's in active feedback with the index computation method. There's also a potential issue, again depending on the level of buy-in, that one should see systematically increasing P/E ratios because of increased overall buying of stocks. That is, in the past, it was not typical for normal people to engage in regular stock purchases (which are held for decades). This would suggest lower dividend yields, which leaves one wondering whether 401ks will become what people think Social Security is, i.e., ever-rising P/Es serving as a transfer from the young to the old that requires continual workforce increases to maintain. Though I'm not in finance, these are just the things that occur to me in thinking, how would I implement an index fund, and what might that do to the system's dynamics. |