WARNING: The Index Fund Bubble

Lets discuss the potential of an index fund bubble, whether or not you should worry, and how to invest long term to build wealth - enjoy! Add me on Instagram: GPStephan

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According to Michael Burry, the investor who predicted the 2008 Subprime Loan Crises and featured in the movie “The Big Short,” says that index fund investing is artificially inflating the prices of the stock market, because people are driving up those prices through index funds - and that’s causing an imbalance between what a stock is now valued at, versus what it’s actually worth.

Secondly, he also warns of what would happen in the event that everyone wants to sell their index fund at the same time - and how that would negatively effect the the price of smaller stocks within that index fund basket.

But is there ACTUALLY any truth to this?

First, I looked at stocks that had just been added to an Index to see if its price DID really go up…and then I looked at stocks to see what happens if they’re REMOVED from the index, to see if the price goes down. Here’s what I found.

When a stock is going to be added to an index, it’s announced AHEAD OF TIME - BEFORE index fund managers can actually go ahead and buy it. This leaves time for individual investors and speculators to buy in, anticipating it being added to the index within the coming week - and trying to make a profit.

When it was researched, it was found that stocks DO generally see a rise in price once it’s ANNOUNCED they’re going to be added to an index - but ONCE they’re actually added to the index, the pent up demand slows down - the stock price drops - and then it returns it a new “normal.”

Long term, however, it was found that adding a stock to an index has no permanent effect on the price

First, to be a part of an index, you actually have to have the merits to be included…you have to be a successful company, have brand recognition, and otherwise have the attributes and market cap to be considered.

Second, the way index fund investing works, is that the fund is weighted towards the biggest companies that make up the largest volume…this means that only the biggest companies get most of the index investment, since THOSE make up the biggest portion of that “basket.” This also means the smaller companies receive very little “index fund” money, because they make up such a small percentage of the overall index.

Third, once a company is added to an index - it must actually PERFORM well, and much of its stock price movement will be from it’s earnings, performance, and ongoing development. Otherwise, if it doesn’t perform well, it’ll get bumped and the price will go down - causing a small percentage of the overall index to go down, with it.

So, given all of this…no, I personally don’t see there being any signs of an index fund bubble - and none of my research points anything to confirm this is a cause for concern.

HOWEVER…as with anything, at ANY time in the market cycle, I WOULD recommend you always:

Have a 3-6 month emergency fund in cash at all times - in a high interest savings account

Invest money you aren’t planning to touch for at least 10-20 years

DO NOT PANIC SELL anytime something drops in price - just stay the course and continue as normal

ALWAYS Diversify your investments - whether it be through index funds, real estate, or bonds

And always…no matter what…smash the like button

For business or one-on-one real estate investing/real estate agent consulting inquiries, you can reach me at GrahamStephanBusiness@gmail.com