If everyone knows a method to make money, that method soon ceases to be a source of profit. The trade becomes crowded and the edge is arbitraged away.
So when does index investing stop working?
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- If all future discounted cash flows are priced in, what is the source of potential appreciation other than multiple expansion from forced institutional buying (401ks, insurance, endowment funds) and naive retail?
Once valuation multiples stretch into incredulity, does the market not begin to behave more like a ponzi scheme (first in, first out) as the money simply trades on itself? Berkshire already holds $400B in cash, enough to buy outright a large portion of the S&P listed companies itself. Is there not already too much cash chasing a fixed amount of value.
Inevitably the risk premia of the market, the fee you are paid to take the risk of funding equity in a publicly traded company, has to contract as more capital crowds the trade. Would it not inevitably equalize with the rate of inflation. Nominal gains would appear healthy, but real returns would have to equalize to near zero.
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Aside from a technical exposition on the market, I believe it is common knowledge that there is "No Such Thing As A Free Lunch." Yet, it is commonly believed that if you index money you inevitable make a fortune holding long.
Is it possible that this is only relatively true, and that an advantage did exist when?:
- Transaction costs and friction were high. Having to walk in to a brick and mortar broker, sign up for a mutual fund. Limited digital connectivity.
- Knowledge moved slower. Research had to be done manually. No mass analyst coverage or access to financial data.
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Is it possible that the success of index investing worked well during a particular set of circumstances? A technological shift in industry behavior + an extended period of GDP growth in the US.
Is it possible that the success of index investing is circumstantial and not an inviolable factual outcome?
If everyone knows about a method to make money, the method will soon cease to be profitable.
byu/lightjon ininvesting
Posted by lightjon
7 Comments
You are confused about how discounted cash flows work. If earnings go up with time, stocks go up with time.
Knowing about it and being good at it are 2 completely different things
> If everyone knows a method to make money, that method soon ceases to be a source of profit. The trade becomes crowded and the edge is arbitraged away.
So true, that’s why prostitution died out thousands of years ago. It was such easy and obvious money and everyone did it that it lost all profitability.
Same with farming, building, all trades really.
So long term investing is dead?
> If everyone knows a method to make money, that method soon ceases to be a source of profit. The trade becomes crowded and the edge is arbitraged away.
This describes alpha, or performance over and above the market.
It does not apply to long term capital investment in profitable businesses
This is the dumbest shit. Profits are not a zero sum game. Options and day trading pretty much are though.
This is where my mother would say, ‘You think too much.’ It’s simple, too many buyers, the return goes down.