Why Indexers Are Toast

Many of you have your entire retirement funds invested in low-cost index funds. Those would include the Vanguard 500 Index Fund Admiral Shares (VFIAX) and the Vanguard Total Stock Market Index (VTSAX), the world’s second and third largest ETFs.

I have some very bad news for you: the sushi is about to hit the fan.

Hardly a day goes by without some market expert predicting that it’s only a matter of time before machines completely take over the stock market. Humans are about to be tossed into the dustbin of history.

Recently, money management giant BlackRock, with a staggering $5.4 trillion in assets under management, announced that algorithms would take over a much larger share of the investment decision-making process. Exchange Traded Funds (ETFs) are adding fuel to the fire. By moving capital out of single stocks and into baskets, you are also sucking the volatility, and the vitality out of the market.

This is true whether money is moving into the $237 billion S&P 500 (SPY), or the minuscule $1 billion PureFunds ISE Cyber Security ETF (HACK), which holds only 30 individual names. The problem is being greatly exacerbated by the recent explosive growth of the ETF industry.

In the past five years, the total amount of capital committed to ETFs has doubled to more than $3 trillion. In fact, there is now more money committed to ETFs than publicly listed single stocks, more than 3,500!

While many individual investors say they are moving into ETFs to save on commissions and expenses, in fact, the opposite is true. You just don’t see them. They are buried away in wide-dealing spreads and operating expenses buried deeply in prospectuses.

The net effect of the ETF industry is to greatly enhance Wall Street’s take from its brokerage business, i.e., from YOU. Ever wonder why the shares of the big banks are REALLY trading at new multi-year highs? I hate to say this, but I’ve seen this movie before.

Whenever a strategy becomes popular, it carries with it the seeds of its own destruction. The most famous scare was the “Portfolio Insurance” of the 1980s, a proprietary formula sold to institutional investors that allegedly protected them by automatically selling in down markets.