The Dangers of Indexing

Mar 1996

Indexing can be a reasonable strategy as long as its acceptance doesn’t change the underlying characteristics of the investing game.  Unfortunately, it clearly does…When hundreds of billions of dollars are poured into just 500 investments, it’s logical to expect that the favored 500 are going to sell at higher prices than they otherwise would have commanded.  I estimate that the S&P 500 stocks are 10-40% higher than they otherwise would  be simply because of indiscriminate buying by indexers.  As a result, the S&P 500 measure has been boosted by indexing, thus making it even more difficult for money managers and mutual funds to keep pace with this index.  Of course, this has increased the pressure on investors to index—thus completing a vicious cycle.  Such cycles don’t always end in an orderly way.