Are we in an Index Fund Bubble?

are we in an index fund bubble?

Index Funds can be a smart investment even in turbulent times

Are we in an index fund bubble? Should you stay the course and keep investing, or should you sell and look for better opportunities? As with most things there is no one size fits all answer. The markets are in a state of turmoil, so it is easy to see why one would think that avoiding certain asset classes might be a good idea. Let’s take a look at index fund investing so you can see if it is right for you.

What is an Index Fund?

Before you can decide if investing in an index fund is a good idea or not, it would probably be a good idea to know what one is. An index fund, in the simplest terms, is a mutual fund that mirrors a particular market index. They are passive investments with low fees. They track the markets as opposed to trying to beat them, and gains and losses tend to be less volatile. For a more in-depth definition you can check the link here.

Index Fund Bubble?

There is some very complex analysis regarding the index fund bubble and its causes. If you care to learn more you can check out this analysis. To give a short summary, the basic argument is that the market gets distorted as money pours into index funds, since money starts to concentrate into a few securities. A simpler explanation is that an index fund tracks a broad index. If the DOW corrects and drops 10%, then the index fund that tracks it will most likely do the same.  The markets are at historic highs as of the writing of this article, and Coronavirus cases are surging. The environment seems ripe for a market correction, and index funds will follow the sell off.

What Should an Investor do?

So, should you invest in an index fund? It really depends. As I said, there is no one sized fits all answer. If you are nearing retirement or are risk averse, then it may be prudent for you to steer clear or have limited exposure to these assets. If you a younger investor with decades to retirement and don’t mind some risk, then an index fund could be a good fit for your portfolio. Even in these wild times investing steadily over time can yield positive results. How so?

History is our Guide

Despite market crashes, war, global pandemics, and market bubbles, the stock market has steady grown and yielded positive returns over time.  200 years of stock market history shows an average return of 8.25%. If you invest in small amounts over a long period of time, then you are almost certain to come out on top.

Wrapping up

Are we in an index fund bubble?  Maybe. Should you be concerned? I’d argue probably not. As long as you have time before retirement and can stomach some short-term losses, then there is no reason to avoid index funds as an investment vehicle. In the long run you will come out with positive gains.

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Comments

  1. Definitely an interesting topic! I’ve had a lot of fun thinking and talking about it with readers.

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