Thread by @GrahamStephan

Index funds have been the safest investment option ever.

Except now, Michael Burry is saying there's an Index fund bubble.

Even Jack Bogle, the creator of Index Funds, warned against it!

Here's a breakdown of the bubble - and what it means for your money. 👇

What's an index fund? It's just a basket of stocks you can buy to diversify risk.

Instead of YOLOing on a stock you found on WSB, you can buy $SPY and own a piece of the top 500 companies in the market.

There's an index for everything - From Gaming to Cows to even Obesity!

But the better part is that while reducing risk, they are also very profitable.

95% of portfolio managers underperform $SPY over a 15-year period. Even Warren Buffett promotes $SPY over his own company!

The cash inflows to index funds have been skyrocketing for this reason.

But this popularity has caused two issues.

First, Price Discovery. People buy the basket without seeing what's in it. All assets in the basket get your money *automatically.*

This can lead to a bubble where buying leads to price rise which leads to buying.

Remember ARK ETF?

Second, Low Liquidity.

IF a large portion of investors sell off index funds - the smaller companies will get hit.

Take the Russell 2000.
Half the stocks have a trading volume of < $5M per day.
25% have < $1M per day.
A large sell-off would affect these companies the worst.

What does the data say though?

It seems like adding a stock to the index would make its price shoot up. It does - But only for a very short time.

There is usually a price rise in the week leading up to the inclusion, but no permanent effect.

Also, price is decided majorly by trading and not by fund inflow. 95% of trading volume is captured by active traders, not index funds.

The chance of a bubble is very low.

What about liquidity? In funds like $SPY, the larger funds are given more weight. $100 into $SPY would give $7 to $AAPL and 1.5 cents to $RL.

A sell-off would affect them proportionately, and it wouldn't be that catastrophic.

There's one concern. When you buy a stock, you get voting rights on it.

If the trend continues, 3 fund managers would dominate 81% of the voting control of every large US company.

But we're not in immediate danger... When's the last time *you* voted for a stock you own?

So we're not at risk of an Index Fund bubble anytime soon, and they're still a great investment.

If you want to dive deeper, here's the full post:
grahamstephan.substack.com/p/index-fund-b…

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